Watching signals and ignoring the narrative of the day usually is the best thing to do when assessing where we are in a market. We’ve all made the mistake of letting information overload leave us like a deer in the headlights.
Use these signals to shine the light the other way and see what’s most likely and least likely. Right now, a correction of some magnitude seems likely.
Utilities Vs. S&P 500
When utilities lead the S&P 500 that’s a signal that people are becoming defensive. A bearish sign.
I’ve been watching lumber since the before the financial crisis. It’s a good tell on economic strength and expectations as it’s so closely tied to housing and business development. There are several relationships to look at as comparisons. The simple sometimes is all we need though. Look at lumber back to before the Financial Crisis.
Lumber trailing gold also is a bearish signal. That started to occur about four weeks ago. It’s not extreme yet, but the trend needs to be watched carefully.
Smart Money vs. Dumb Money
Sometimes it’s this simple. The big guys are selling to the little guys. When has that worked out well?
I use Sentiment Trader as a shortcut to many studies of correlations. I think this one is among the most telling.
While this is not a sign of a “right now” correction, it’s a typical sign of a “very soon” correction. Magnitude is of course always the issue. I discuss that below.
Risky Expensive Option Trades
Not only is the dumb money chasing, it’s doing it with call options. Friday is a big expiration day.
The two Sentiment Trader charts buoy the “greater fool” theory argument. While I just talked about Millennials starting to take over the market, they have some learning to do. Or maybe some teaching. We’ll see if they switch to buying puts over buying calls. Here’s the piece that I cover Millennial trading behavior and what might be coming next:
Huge Trend Resistance
It’s very rare that stocks break out of a long range. This “megaphone” has a clear top end of the range. Getting through the top red line would be extremely unusual as well as dangerous.
The broadening bottom means that there’s a lot of room for downside.
This is a technical formation that almost always leads to a correction. The only question is, how far down? The “orange box” would be standard or typical. Above is very bullish and below is very bearish.
With all the QE, anticipated fiscal stimulus, zero rates for years and likely a new president that trading partners would prefer, the top half of the orange box seems most likely to me. Keep in mind downward momentum in a levered and thinly traded market can have a sharp drop, much like March. That would be something to buy with every penny, i.e. bottom of and below the orange box.
Bottom Line For Investors
As I have discussed for a few months now, the rally is not supported by the fundamentals. I have even asked: Does it matter that stocks are overvalued?
The answer is that at some point valuations will matter. When the reversion to mean occurs, it can be partial, full or overdone. We don’t know which it will be until it gets here.
That’s why we pay attention to technical indicators in real time. As much as we all want to be fundamentalists, the reality is that the sentiments of fear and greed matter in the short run.
Here is the daily Relative Strength Index. Like the indicators above, it shows we are nearly in overbought territory. Look at what has happened other times this has occurred the past 25 years.
Keep trimming if you are not to your low equity allocation range. And be careful with any purchases during a correction until there’s reasons to buy quickly.
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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.
Additional 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.