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What Is The Market Saying?

sp-500-pmo

Click on any chart for a full size version

I thought we ought to take the temperature of the market and see what it is trying to tell us about the status of the current bull run. To do that, I have included four long-term trend charts that I have watched over the years that help me know when to get conservative with client money and when to get aggressive. Let’s see what they say.

Above is a 20-year chart of the monthly S&P 500 with the Price Momentum Oscillator (PMO) at the bottom. You can see that I have circled various points in time where the blue PMO line has crossed over its red indicator line. A cross to the downside indicates the market is weakening and a cross to the upside indicates the market is strengthening

The change in the PMO generally coincides with a change in trend for the stock market (see the circles in the index where it crosses below its long-term moving average). As prices begin to weaken and investors’ buying enthusiasm wanes, the PMO captures that before prices fall enough to do too much damage to a portfolio. The really important thing to note here is on the magnification of the chart at the far right. You can see that the PMO has had a negative cross-over – IF history provides any indication as to patterns within the stock market, the stock market should weaken and turn down soon.

Notice I said IF because chart watching is an art and not a science.

trix-divergence

This chart is another one that concerns me. It is a daily chart of the S&P 500 compared to the TRIX Indicator. The TRIX is a momentum-only indicator and tells us when the market is starting to weaken. You can see I’ve drawn boxes around times when the TRIX is pointing to a change in market direction and I’ve drawn circles around the market’s divergence with the indicator UNTIL it changes direction. The important thing to see here is on the far right side of the chart – there is a negative divergence where the TRIX has turned negative but the market continues to move higher. IF history provides any indication as to patterns within the stock market, the stock market should weaken and turn down soon.

Notice I said IF because chart watching is an art and not a science.

sp-monthly

The final chart above shows the monthly S&P 500 index compared to its 10 month moving average and includes a Relative Strength Index (RSI) – a momentum-only measure of the speed and rate of change of a price move. In this one, I’ve drawn circles around times where the RSI is showing readings that are either overbought (where there are too many bulls – a contra-indicator) and oversold (too many bears – also a contra-indicator). I have also drawn circles around times when the S&P has crossed over its 10-month moving average line. You can see that when they both happen, it represents a fairly long-term change in trend. At the moment, we have the RSI showing an over-bought reading but the S&P still above the 10-month moving average. IF history provides any indication as to patterns within the stock market, and the S&P index crosses its 10-month moving average to the downside, the stock market should weaken and turn down, possibly into more than just a correction.

Notice I said IF because chart watching is an art and not a science.

These are three fairly important charts for me and at the moment they are flashing caution. We have built up a 4% to 5% (of equity exposure) cash cushion in client accounts as these charts started to turn negative. We will hold onto that until we see definitive sighs of a trend change to the downside – if it happens.

I want to be clear – there is no guarantee that the market will go down. It could continue higher or even move sideways for a time. In fact, here is where the art of chart reading comes in – this chart shows that the top three may be flashing false signals:

sp-with-regression-channels

This chart shows the S&P 500 Index with a regression channel that I’ve drawn. You can see that the market has moved within this channel for the past 6+ years. The channel is marked by upper and lower boundary lines with a mid-point line. The current move by the market is very consistent within the upper half of the channel. This type of move indicates a strong uptrend, and until we see it move into the lower half of the channel the trend is definitely in tact.

So for now I am going to exercise my art degree and carry on with the plan to be cautious but remain 95% invested until all four of my indicators tell me that a correction is near.

Mark