The Near-Term Market Environment Will Be Well Suited For Traders

| About: SPDR S&P (SPY)

Summary

I make near-term stock market forecasts. If the market goes against me, I will cut my losses short and inform readers about the reversal within a few days.

I activated the "Sobon Oscillator" last August. Thus far, its track record has been pretty good. Evolutionary changes were made as needed. It should now be more reliable than it.

My conclusions won't always be correct. The news flow is dynamic and also unpredictable by everybody, not just me. New market-moving events can work in my favor or against me.

At 210, the SPY is 1% below its high for 2016. There is much resistance on its price chart up to 213 and probably beyond. Its upside potential is limited.

The economic and political situations extant leave much to be desired. This is a market environment best suited for traders who can make trading decisions while holding their noses.

Summary

Introductory Considerations

(1) George Bernard Shaw wrote, "The reasonable man adapts himself to the conditions that surround him... The unreasonable man adapts surrounding conditions to himself... All progress depends on the unreasonable man." Being an unreasonable man, I constructed the Sobon Oscillator because I wanted a disciplined approach that I could use to forecast the near-term performance of the stock market. It has long been a work in progress. Being original, it had to evolve because there was no one who could have shown me how to do what I do. In recent months, my oscillator (imperfect although it always will be) was good enough for me to make actionable decisions about the near-term performance of the market. Although a success rate of 100% would be impossible, I believe a success rate of 80% is doable.

(2) In my last article, I concluded that the market would go down. That was the indicated direction for the market at the time the article was posted. However, an uptrend reversal started the very next trading day. My computer was not programmed to detect a reversal like that on a timely basis. But it is now. So such a reversal will not surprise me again.

(3) Henceforth, whenever I make a forecast about the market's near-term trend, it will be good for the next few days on a rolling basis. I track the market daily to see if it is going "with or against" me. What I do is technical analysis. It deals with the historical sweep of stock price movements up to the last trading day. So I am always at the mercy of the news flow. When a market-moving event occurs (be it fundamental or technical), it can be bullish or bearish. I need to know if it is one or the other. If it is going against me, I intend to cut my losses short and add a comment to the article informing readers about the reversal.

(4) In one of my favorite books called "Self-Reliance", Ralph Waldo Emerson wrote, "A foolish consistency is the hobgoblin of little minds... Speak what you think now in hard words, and tomorrow speak what tomorrow thinks in hard words again, though it contradicts everything you said today... 'Ah, so you shall be sure to be misunderstood.' … Is it so bad to be misunderstood? Pythagoras was misunderstood, and Socrates, and Jesus, and Luther, and Copernicus, and Galileo, and Newton, and every pure and wise spirit that ever took flesh." Whenever I need to change my opinion about the direction for the market, I will do so as soon as possible. Let the critics say whatever they may. Far more often than not, a critic is a guy who knows how something should be done but he, himself, can't do it. Constructive criticism is welcomed. Why not? When I accept good advice I increase my own abilities.

And (5) all of the statistical data used in this article was processed in my workbook. And, all of the price and trading volume data fed into the workbook was downloaded from Yahoo Finance. I make extensive use of index numbers in the analysis that I do. So wherever you see multiple price lines on a chart or bars where trading volume data is shown, the performance of one line or bar is statistically comparable to any other such item relating to stocks or ETFs.

Interest Rates and the Fed's Dog and Pony Show

The chart below shows the performance of interest rates for the 5-, 10- and 30-year Treasury notes and/or bonds for the last 150 trading days. At the present time, their respective yields are 1.17%, 1.64%, and 2.45%. Such are ar least 60% below their historic norms. The 5-year note is six basis points above its low made four months ago while the yields on the 10-year note and the 30-year bond are at their lows for the last 150 trading days.

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Recently, when Janet Yellen spoke about raising rates, the aforementioned rates increased and then they dropped down to where they are now. Apparently, the investment community doesn't believe that the Fed will raise rates any time soon. And why should it?

Fed officials have often cried "wolf" in recent years as they expressed conflicting opinions about raising rates in speeches that they made with ad nauseam frequency. It was apparent to me that such was a blatant exercise in obfuscation because of the ways the hawks and doves expressed their conflicting points of view. Frankly, I believe that they will continue to find excuses for not increasing rates in coming months. Because of the Fed's track record, why should I think otherwise? Or as George W. Bush might have said as he once so "ineloquently" did, "Fool me once, shame, shame on you. If you fooled me you can't get fooled again." If you can figure out what the hell Georgie was talking about, you might be able to figure out what the Fed will do.

Speculative Interest in the Market Has Been Waxing

Since February, there was a profound turnaround in investor sentiment as such relates to the stock market. I don't know how long this bullish situation will last. But I do know that when speculative interest in the market waxes, the stock market goes up. And when it wanes, the stock market goes down. It is too soon to tell but the sharp drop in stock prices on Friday (June 10) may be a signal that the bullish sentiment is waning.

Look at the next chart.

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It shows the performance of seven well-known ETFs during the last 150 trading days (that's a little bit more than seven months). Also shown are (1) my index of 450 stocks (the dark blue line) and referred to in the legend as S450, and (2) my index of 43 technology stocks (the light blue line) which is referred to as Tech43. The S450 index is unweighted (as is the Tech43) and it correlates well with the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA: RSP), the black line on the chart. The Tech43 index has been a fairly consistent outperformer of many of the other indexes during the last few years. The other equal-weighted index charted, the First Trust NASDAQ-100 Equal Weight Index ETF (NASDAQ: QQEW), is the light green line.

All of the other indexes shown are capitalization weighted, and they can be identified by the colors of their lines as shown in the legend on the chart. They include the S&P Industrial Index (NYSEARCA:SPY), the NASDAQ 100 (NASDAQ:QQQ), the Russell 2000 (NYSEARCA:IWM), the S&P 100 large-caps (^OEX), and the S&P 400 mid-caps (NYSEARCA: MDY).

Because the SPY is widely considered to be the most important of all market barometers, I use it as the benchmark indicator for the general market. The hashed orange line on the chart is the 150-day high for SPY. At 210, the SPY is priced near its high for 2016, and just three points below its all-time high of 213 made in 2015.

For perspective, let's consider what happened with these indexes since they made bottoms on their price charts in February: All of them bounced about 80 trading days ago (as framed by the white box and the area to the right of it on the chart) and then trended higher. However, some did so more dramatically than the others and therein lays one of the keys to understanding the waxing of speculative interest: the small- and mid-cap stocks (which are generally considered to be more "speculative" than the larger so-called "investment-grade" stocks) outperformed the large-cap stocks. So, the RSP outperformed the SPY, the MDY outperformed the ^OEX, and the QQEW outperformed the QQQ. The SPY, RSP, MDY and S450 are about 1.5% below their highs for the last 150 days. The ^OEX and the IWM were 1.8% and 3.0% below their respective highs, while the QQQ was down by 5.5%.

The second key to understanding the waxing of speculative interest relates to the rally in stock prices that started 15 trading days ago (as shown in the area to the right of the white box) when the IWM outperformed all of the other indexes most of the time. The increases in the prices of some of these indexes were so sharp that the price lines on the chart came close to going parabolic. If that had happened, it might have been a sign that a sharp correction in the market was imminent because history shows that such insanity does not last very long. But sanity returned to the market on Friday and the speculative binge ended.

A third key to understanding the current level of speculative interest relates to valuations. (1) The economy and the stock market continue to be on "life support" provided by the Fed. (2) But P/E ratios for stocks are well above historic norms and dividend returns on many stocks are abnormally low. And, (as discussed above) yields on Treasury notes and bonds are well below historic norms. (3) Portfolio managers have been reaching for yield. With the Fed likely to increase interest rates some time in 2016, portfolio managers have been holding onto equity positions because they don't want to hold low yielding bonds, which could be a lousy alternative for stocks because sooner or later the Fed will have to normalize interest rates. And (4) wittingly or otherwise, the investment community is assuming that somehow the economy will transition smoothly as the Fed withdraws its stimulus. That is about as speculative a wish that investors could possibly make because of imbalances in the economy which the Fed helped to create. Redress of such imbalances could easily become disruptive.

With all of the uncertainties relating to the economy, the monetary policies of the Fed, the political situations as they relate to the do-nothing Congress and upcoming elections, it is likely that there will be more volatility in the stock market than we have seen in recent years.

Look at the next chart.

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(1) The top panel on the chart needs no further explanation because it is a reproduction of the previous chart and such was just discussed. It is shown here to provide perspective for the other two panels.

(2) The second panel shows the performance of the SPY (the red line) and its related index, the RSP (the solid black line). There is a set of black, blue and green hashed lines on the chart. Those are 10-, 21- and 43-day moving average trend lines that relate the SPY. I use them to detect a trend reversal by the SPY (or any other stock or ETF I may be interested in). About 16 to 18 trading days ago, the SPY broke below the upward sloping trend lines (as did the RSP) and that indicated it should go lower. (That was when I wrote my last article and stated the market would go lower for reasons other than these. However, until Friday, stock prices increased steadily since then.)

(3) The bottom panel on the chart shows what I am now using as my "trend indicators." During recent weeks, I did a test to learn what (if anything) was wrong with such indicators that I used previously. And I learned that nothing much was wrong with them. The indicators that I used for the test are shown as the dual pink and dual light blue lines on the chart. They were derived from the family of moving average trend lines that have long been parts of the oscillator (these will be shown on the next chart). Because (3a) the new indicators are a better fit with the oscillator than those used previously, and (3b) I was able to chop two megabytes off my computer program, I switched to the new indicators. But the other ones could still have been used.

(4) Now, I want to show you some things about the bottom panel that are very important. The pink dual line is the "Short Crossover Indicator" (SCI) and the light blue dual line is the "Near-Term Trend Indicator" (NTTI). They are derived from moving average trend lines for 450 stocks that are parts of the oscillator. When the SCI crosses below the NTTI (as shown in the chart) that will weaken the NTTI, and if the NTTI drops below the zero line, that could be a very bearish indication for the market.

And also (5) the other indicators shown as columns on the panel are breadth indicators that show percentages for the 450 stocks that are making new highs or lows (S1), the highs and lows that are new when compared to the previous day (NU), and the highs and lows that are repeats from the previous day (RE). Scan the panel from left to right and you will see that the market doesn't go up much unless these indicators are strongly positive on successive days, and it doesn't go down much unless they are strongly negative on successive days.

For the remainder of this article, my focus will be on the performance of the market during the last 15 trading days.

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This chart shows the five major parts (having a total of 31 indicators) in the Sobon Oscillator. (1) The top panel shows daily percentage price changes for the major market indexes to indicate direction and magnitude. (2) The second panel shows the volume of trading in such to indicate conviction. (3) The third panel shows the breadth indicators for the 450 stocks included in the oscillator that are making highs and lows to indicate strength or weakness. (4) The fourth panel shows breadth indicators for moving average trend lines for the stocks to indicate strength or weakness. And, (5) the fifth panel shows the SCI and NTTI indicators which were derived from the 450 equally weighted stock price trends to indicate direction. None of these parts is more important than any other because all of them are parts of an integrated whole. I get to choose which parts I will emphasize when I draw a conclusion. But I usually focus on the bottom panel when I finalize a decision because it summarizes significant developments taking place in the third and fourth panels. But there have been times when I focused on the first and second panels.

The market's near-term trend was down until 15 trading days ago. Since then (as shown in the white box) it bounced and then trended higher until Friday (June 10). The second panel on the chart shows that the daily volume of trading was average but the price gains for the major market indexes (the top panel) were small (indicating resistance) until Friday. With much overhead resistance at the 213 level for the SPY as shown on its chart for the last year, it looked like the near-term trend for the market was both limited and ill-defined (until Friday) while lacking downside leadership. Friday's market action was decisive and changed the calculus: the sharp decline in stock prices was pervasive and all of the indicators showed pronounced weakness. That confirms what I had concluded before I began writing this article on Thursday. It was likely that stock prices could be volatile while moving within a trading range during the near-term future. So I am going to repeat what I wrote near the beginning of the article: The economic and political situations extant leave much to be desired. This is a market environment well suited for traders who can make trading decisions while holding their noses.

When writing an article like this, I never tell readers what they should do in the market. I write the story according to the way I understand it. I may tell readers what I am doing when I buy or sell stocks. But it is up to them to make their own personal investment decisions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.