Credit: Shutterstock photoWe all know that you shouldn't judge a book by its cover. We also know that some people can be read like an open book. But how can you read the stock market's signals?
Not by its cover, that's for sure. To many, the market's signals are not much more than a hodgepodge of random indicators that refuse to line up for a consistently clear read.
The lack of discernable direction in itself is a sign that the rally from the March lows will fail to usher in a new bull market. Before we talk about the long-term prospects of stocks, let's take a look at the short-term direction.
Short-term outlook:
Even though the Dow Jones (DJI: ^DJI) and S&P 500 (SNP: ^GSPC) reached new recovery highs on July 11th, ETFguide noted that stocks looked tired. On June 11th, the ETF Proift Strategy Newsletter recommended that, 'conservative investors and those wanting to limit frustration should use the current levels to raise cash and wait for the next big profit opportunity.'
How can you discern when stocks look tired? There are a number of indicators, two of which are volume and non-confirmations. Even though the Dow Jones (NYSEArca: DIA) and S&P 500 (NYSEArca: SPY) did reach new highs, higher beta stocks had cut out earlier and were already heading south.
Such higher beta stocks included the iShares S&P 600 SmallCap Index ETF (NYSEArca: IJR) and real estate stocks, as represented by the iShares DJ US Real Estate ETF (NYSEArca: IYR).
A lack of commitment for volatile small cap stocks indicated that investors have become weary about the sustainability of the recent run-up. Real estate stocks were the first to break down years ago and seem to continue that pattern. The same holds true for the financial sector. The Financial Select Sector SPDRs (NYSEArca: XLF) and SPDR KB Bank ETF (NYSEArca: KBE) topped over a month before the overall market did and have been heading lower ever since.
A fractured market is a sick market
The inability of the major indexes to move in sync over the past few weeks further intensifies bearish forces. The Nasdaq's (Nasdaq: ^IXIC) overall performance did not rhyme with the broad market indexes and produced a set of minor non-confirmations. A fractured market is a sick market.
In retrospect, it becomes obvious that the June 11th high marked the head of a head-and -shoulders formation in a bearish context. Many traders look for head-and-shoulders signals as they often provide powerful opportunities.
The early May recovery highs produced the left shoulder of the pattern, while the July 11th highs marked the head. The recent decline and late June bounce provide the right shoulder. The neck-line - which marks a major support line - runs through 8,200 for the Dow and 880 for the S&P.
Yesterday, both the Dow and S&P dropped below the neck-line, pointing towards more bearish potential.
On a smaller scale, the head-and-shoulders formation reflects the investors' eternal struggle between the fear of losing money and the fear of losing out on making money. Rising prices around the head and both shoulders lead investors to believe that they'll lose out on making money, thus tricking them into buying at higher prices.
Long-term outlook:
On a larger scale, this kind of investor sentiment (aside from being fascinating to the successful spectator) provides important and reliable clues regarding the market's true whereabouts.
The ETF Profit Strategy Newsletter has referenced investor sentiment a number of times recently. On December 15th, for example, we issued the following warning: 'Optimistic sentiment, which should be more visible above Dow 9,000, gives way to further declines.' The Dow topped above 9,000 early in January and tumbled 30% thereafter.
In a March 2nd Trend Change Alert, the newsletter commented as follows regarding the intensity and eventuality of the current rally: 'A multi-month rally, the biggest rally since the October 2007 all-time highs, should lift the indexes by some 30-40%. The point of exhaustion is likely to happen at a point where optimism takes over and investors think that the Q1 2009 lows are here to stay.'
Optimistic sentiment can be measured in a number of ways, one of which is an appetite for risk. Fear of losing money drove the yield spread between high quality Treasury bonds (NYSEArca: TLT) and junk bonds, also disguised as high yield bonds (NYSEArca: JNK), to all time highs in 2008. The renewed appetite for riskier junk bonds has now reduced the spread back to where it was last summer.
Optimism surrounding the July 11th highs was much more pronounced than at any other time since the January highs, but below what we would expect to see at a major market top. This implies that the market will take another stab at making new recovery highs, once the current correction is over.
Don't trust the crowds
The mere presence of investors' euphoria indicates that the rally from the March lows is nothing more than a counter trend rally. New bull markets climb a wall of worry; they don't ascend an elevator of hope.
Even though the government's stimulus packages seem to be doing the trick they will actually end up hurting investors, especially investors who believe in the healing powers of flawed programs. Similar to the above described head-and- shoulders pattern, the hype surrounding the solutions proposed by Bernanke, Geithner and co., will trick many unsuspecting Americans into believing that higher prices are ahead, therefore, magnifying losses.
The most recent issues of the ETF Profit Strategy Newsletter include a detailed short, mid and long-term forecast, along with corresponding ETF profit strategies, a target range for the ultimate market bottom and detailed research reports uncovering the major flaws of the government's stimulus package.
With the right type of research, even the market's movements become like an open book to savvy investors.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
