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By Costas Bocelli - Creator: Channel Trading Secrets
Are you a buyer of the market right here?In my Tycoon Report article last week -- Market Rally to Hit the Pause Button? -- I made the argument that this is probably not the best time to get aggressive buying into the market. My suggestion to you was to simply keep your cash on the sidelines and wait.
And, while it’s still possible we can go higher from here, I cited four reasons why you should remain patient not worry about the prospect of “missing out” on the market ripping higher in the near-term.
The odds still point to us being in store for some type of corrective action to alleviate the overbought market conditions. That means either more consolidation or a pullback to lower prices.
And since my report just a week ago, two more screaming red flags of caution have come to light. In a moment, I’m going to share them with you, which will bring our "total reasons not to buy the market right now" to six.
The previous four that I already mentioned still hold true...
The biggest reason to remain patient is, of course, the array of fiscal issues that Washington must confront. The debt ceiling debate and dealing with the sequestration spending cuts should provide a glass ceiling of resistance. And if history serves as any guide, any resolution will come with only seconds to spare, meaning that the market will be forced to deal with more uncertainty and political overhang for at least the next four weeks. The Treasury has last estimated that it has enough cash to meet all its obligations through mid-February.
The gains in the broad indexes have indeed ground to a trickle as they scrape up against key areas of technical resistance. In fact, the S&P 500 index has closed nearly unchanged for the past four consecutive sessions! When I said the market was likely to hit the pause button, I didn’t mean to imply that it would literally pause like the hands on a broken watch.
What I meant, of course, is that we’ve probably achieved a short-term top (or close to it), and the risk to the next move is likely to be lower from here.
Bottom line is that the 1465-1475 level in the S&P 500 index should act as resistance, and if the index does trade above that threshold, it should not be able to significantly break out and achieve escape velocity until Washington confronts the fiscal issues that were pushed in the year-end deal.
We’ve had fifty or so companies report earnings, and they are beating analysts' estimates at an above average pace. As I mentioned last week, the earnings bar has been lowered substantially, and the better-than-expected results reported thus far have not exactly stirred Mr. Market’s animal spirits.
The Financials are one of the most significant sectors of the market and have been leading the intermediate-term rally with strength over the past six months. We’ve seen a slew of the big banks report strong earnings, yet the market has yawned. Perhaps the good news is priced in, but the reality is that this earnings season is unlikely to be the catalyst that will break the broad market out to the upside over the next several weeks.
And the fourth reason we cited was that the market landscape has gotten too complacent. We highlighted how the extremely low reading in the VIX is indicative that protecting against downside risk is not exactly very high on investors' lists of daily worries. And, when the VIX gets this low, it usually sets the stage for a market top to materialize. The VIX still has a sub-14 reading and the condition remains a sign of caution.
That brings us to two more reasons why we should be cautious right now and not be in any rush to buy into the market...
First, it seems like everyone has all of a sudden gotten wildly bullish. Whether it’s because of the Fiscal Cliff deal that averted a massive tax hike on 98% of wage earners, or simply due to the fact that the stock market making a fresh five-year high, it’s caught the retail public’s attention.
Last week, investors poured massive amounts of money into US based mutual funds and exchange traded funds. The total weekly inflow was the strongest since mid-2008 and the fourth largest since 2000 according to Lipper.
But what was most telling is that the huge spike of money flow into long-only stock mutual funds -- which attract the pure retail investor -- was the highest since May, 2001. Usually, when a massive herd of retail investors are thundering all in the same direction, it’s best to seek an alternative route.
Especially when that direction starts with BUY, and at a five-year high!
You see, along similar lines as the VIX being used as a contra-indicator to gauge investors' perceived risk attitude, big spikes in retail money flow can also be used in a similar fashion, especially when market prices hit extreme highs and lows.
And the last of our six reasons not to get too bullish here...
Not only has the retail investor all of a sudden gotten bulled-up, but the investment advisory community has also turned overwhelmingly bullish.
The latest Investors Intelligence Advisors Sentiment Index has now produced a reading that generally coincides with medium-term market tops. The index is basically a culmination of the forecasts and general sentiment of investment newsletter writers derived through their advice and written commentaries.
And the latest readings paint an overly bullish picture. It turns out that 53.2% of the sample is bullish. That level of optimism coincided with previous tops made in September and March of last year.
When you also take into account that only 22.3% of the advisors sampled are bearish, which marked a seven month low, you get a difference of 30.9% between the bulls and bears. That differential is tracked, and when the spread expands to above 30%, bullish sentiment is seen as overly optimistic and sell-offs tend to occur.
Again, it’s a contra-indicator like the VIX and retail order flow. And they tend to work best when price, sentiment and fear gets overly stretched like we’re experiencing right now.
But between now, the Fiscal Cliff hurdle, and then, the market will move around.
And right now, many signs suggest that the market is poised to trade lower before heading significantly higher. That could be great news for investors waiting to buy great companies at lower prices.
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Costas began his trading career in 1998, at Gateway Partners, an Equity Options Trading Specialist Unit on the Philadelphia Stock Exchange (PHLX). During his successful tenure, and though unprecedentedly volatile trading levels, Costas boldly and adroitly navigated the global "financial meltdown" that saw the downfall of the hedge fund and of Long Term Capital, and the Russian Currency Crisis. Having achieved the coveted Senior Equity Options Market Maker position for his firm, Costas eventually left to join a proprietary trading desk, where he successfully makes markets for large customer and institutional orders. In addition to his more than 7 years of experience as an options market maker, Costas has also trained and educated many junior traders on option theory, risk analysis, and strategy. His passion is helping self-directed investors achieve all of their financial goals through a clear, practical understanding of the power of options and of the many benefits of trading in a proven systematic way. |
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