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Reflections on the Market

Index Indicators

Click on the chart for a larger view

I haven’t posted this chart in a long time, but thought it would give you a feel for some of the market internals that have me concerned.

Although it is not included in this chart, the S&P 500 is still trading greater than 10% above the 200-day moving average – an area that I’ve written about a lot here on the blog. What I do have to show you is a longer-term version of this chart that covers the entire secular bear market of the past 15 years.


This chart gives you a feel for the price of the S&P 500 compared to its 200-Week moving average (the red line), with the two blue bands representing the price 25% above and below the average. Its easy to spot when the market gets euphoric and trades at or above the top line: the late 90’s when valuations got completely out of sync with reality as so many people were quitting their jobs to become day traders because the market could only go up; 2007 before the sub-prime mortgage crash; and today we are back above the blue line due to the monetary stimulus (aka, money printing) by the Federal Reserve that again has everyone believing that as long as they keep the presses cranking, stocks will only go up.

But, lets get back to the top chart.

The middle section of the three is the one that is the most telling for me. This section shows the NYSE Composite Index (the gray bars) overlaid with the Summation Index (the red line) and its 5-day moving average (the blue line). You can see that the red line has rolled over and is about to cross the blue line. When this happens, it historically is a leading indicator for a pullback in the stock market. Sometimes its a few percentage points and sometimes its much more.

To get a feel for how big of a pullback, you need to look at the top and bottom sections of the chart for confirmation. The top section shows the relative strength index for the NYSE Composite Index – you can see that this indicator is falling pretty sharply. The bottom section of the chart is the graph of the McClellan Oscillator – the easiest way to understand it is that it’s the short-term version of the Summation Index.

Both the Summation Index and the McClellan Oscillator measure the breadth of the market, based upon the relationship of stocks advancing in price compared to those declining in price. It is an oddity of the way the market indices are calculated that they can still be going up even when more companies are falling in price than increasing in price. Eventually, as more and more companies fall in price than go up, the market indices start to reflect that. These two measures can help you spot changes in market direction before they show up in the S&P 500 Index, the NYSE Composite, or the NASDAQ, to name a few popular indices.

So, I’d look for the market to pull back at some point soon – the question of course is how far. A case can be made that the market is just getting exhausted based upon an examination of trading volume – during the move higher from the June lows, volume has been less than its 50-day moving average. You can see that in the graph below:


The red and green bars at the bottom of the chart show you the daily volume with the blue line representing the moving average. What is more interesting, though, is the black line that was trending up but has flattened out in the past week. That line is the On Balance Volume line and represents a cumulative measure of up-day volume less down-day volume. It is a good representation of what the institutional money flow is doing, and if we are starting to see a flattening that might lead to the downturn in this indicator, then there will be less money bidding stock prices up.

The top part of that graph is just the daily price candles with several short term moving averages. If you squint, you can see that we are now trading below the 8-day moving average and starting to test the 13-day moving average – more signs that market is weakening, although a move back above the 8-day would indicate a continuation of the recent up-move from the June lows.

So, what this means is that we are sticking with the plan I wrote about here: we have stop losses set on a number of holdings that we classify as sale candidates based upon either a deterioration of their fundamentals (eg, earnings growth is slowing or macro forces are impacting their future) or their valuation has gotten ahead of their earnings and we now classify them as expensive.

We have also identified purchases that we will execute after the market pulls back (if it does pull back as the indicators are telling us) so that we can continue to get money into the market at reasonable levels. The tell for us on when to pull the trigger on the buys will be when the indicators that pointed to a down move change direction and point to an up move.

Remember – invest what you see not what you believe. You might believe the market can only go up with all of this Fed money printing, but believe what you see happening to the prices of stocks – and right now I see more stocks declining in value than increasing in value.

We have also been working on changes to our fixed income portfolios which I’ll write about in a day or two (subject to how my week goes) before I leave for a few days of whitewater rafting.

Enjoy the cool weather and I’ll be back, soon!

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PS – Florence Ballard is no relation…Click to find out more about her