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Signs Point to an Overextended Bull Market That Could Sell-Off

Posted
1/15/2013 5:00:00 PM
By: StreetAuthority
Referenced Stocks:DGZ;GLD;IWM;QID;SPY

Thestock market consolidated its gains last week while waiting for news.Earnings announcements this week could push prices out of their two-week trading range.

TradersWill Get the News They Want This Week
Stocks spent last week consolidating the large gains from the first trading day of the year. SPDR S&P 500 ( SPY ) gained 0.48% and PowerShares QQQ (Nasdaq: QQQ) , anexchange-traded fund (ETF) that tracks the 100 largest Nasdaq stocks, added 0.95%. The iShares Russell 2000 Index ( IWM ) , anETF that tracks small-cap stocks, was the biggest gainer among major stock market indexes two weeks ago, but added only 0.11% last week.

Odds favor a pullback, as I wrote last week. In thefutures markets , smartmoney continues to sell while small speculators are excessivelybullish .

A popular sentimentindex , the AAII Investor Sentiment Survey, also shows that individual investors are growing increasingly optimistic. The percentage of bulls jumped 7.7% last week and is now at 46.4%, significantly above the long-term average of 39% bulls.

Individual investors are also putting real money behind their opinions andequity mutualfunds reported their largest inflow since May 2001. These numbers indicate that optimism is becoming excessive in the stock markets, a condition more often seen at tops than bottoms.

In addition to sentiment, earnings estimates continue to drop. S&P began their weekly analysis by noting, "Currently 18 of 28issues that reported earnings beat their expectations. However, the narratives have been negative."

This indicates company management expects to see the slow growth in theeconomy continue and the economic news is still bad. Global economic weakness shows no signs of turning around. In fact, realGDP in the euro zone probably contracted for the fifth consecutive quarter in the fourth quarter of 2012. The euro zone is a large trading partner of the United States with annual trade topping $1 trillion. It seems unlikely the U.S. recovery can accelerate until Europe is growing.

Despite all the negatives, major stock market averages are up 5%-7% in the first eight trading days of 2013. A pullback seems likely and chasing stocks at this point is a high-risk strategy. Thisbull market is nearly four years old and is overextended. Stocks are at the upper end of a 15-year trading range.

Long-term and short-term charts are overbought and this current bull market has delivered bigger gains than the previousbull , a sign that it could be near an end. Withearnings season picking up this week, the best trading strategy is probably to sit on the sidelines and wait to see how markets react to the upcoming news.

ProShares UltraShort QQQ ( QID ) , a leveraged, inverse ETF that tracks the Nasdaq 100, hit the stop-loss at $28 last week and was closed with a loss of 9.79%. That was certainly disappointing, but given the risk in the stock market, that ETF might be the best buy again within the next few weeks.

Gold Selling Accelerates as Price Moves Sideways
SPDR Gold Trust ( GLD ) gained 0.39% in active trading last week.Volume was well above average on Thursday and Friday, but GLD ran into resistance at the 20-daymoving average .

Gold remains under pressure ashedge funds have been large sellers since the end of November. Large speculators have decreased their holding by 26% in the past six weeks, according to the Commitment of Traders (COT) report.

Despite the heavy selling, an indicator based on that data shows that the selling could continue. The indicator converts the raw COT data to an index similar tostochastics and stands at 30. It usually falls below 10 before gold prices bottom.

PowerShares DB Gold Short ETN ( DGZ ) , an inversefund that gains when gold prices fall, fell 0.41% last week but is still a buy.

Action to Take --> Buy DGZ up to $12.25. Maintain stop-loss at $11.25.

This article originally appeared on ProfitableTrading.com:
Sell-Off