By Chris Rowe - Creator: Technical Analysis Millionaire
Over the last 30 years the stock market (S&P 500) has had a Compounded Annual Growth Rate of 11.19% (including dividends). Can you think of a better place to put your money than into the stock market?
Well, it depends on who you ask, and when you ask them.
When markets are near peaks, it opens up doors for salesmen -- er, I mean financial professionals -- to throw a really sexy pitch right over your plate, convincing you to let them put your money to work. They can tout the stock market as having the highest returns when they're near their highs.
But when you should really be investing in the long-term stock market is when they are forced to explain unappealing returns -- when markets are at lows.
Because returns seem more appealing when stock markets are at high levels, at stock market highs, money comes flowing in -- mainly into mutual funds -- because individual investors are excited by the media commentary as well as the returns they've been pitched. So individual investors notoriously invest at major peaks.
How do we know, relative to history, when this is happening?
When you see a spike in stock mutual fund "inflows" it's a warning sign to bullish long-term investors. Individual investors are moving money into the stock market. This is the INDIVIDUAL INVESTOR'S decision.
At the same time, the mutual fund MANAGERS (who are supposed to be the "professionals") are also known for being the most bullish at market highs. This can be easily seen when you check the cash levels the mutual funds have and notice they are extremely low (e.g., when mutual funds are sitting on a 4% cash position it means they are 96% invested, leaving little room for more demand to push stocks higher, and leaving lots of room for supply to knock prices down). How much exposure to the stock market the mutual fund has is the FUND MANAGER'S decision.
Using Roy Ashworth's chart below, we can compare the cash levels the mutual funds had to where the S&P 500 was at the time. The S&P 500 is the red line, and cash levels are represented by the blue line.
On the lower left side you can see the "%" of cash they held. It's easy to compare the peaks in the 70s, in the year 2000, 2007, and most recently at the 2011 top, the 2012 top, and once again, today (without having a confirmed top yet).
Currently, mutual fund cash levels (the FUND MANAGER'S decision) are around 3.8%. Cash levels have recently started increasing again. If you study the historic charts, you will find that FIRST cash levels are anemic and then they increase right before the market tops out. It appears this is happening.
In the chart below, you can see the same data (lowest part of the chart but unable to go back to the late 1960s), but you can also see the recent spike in mutual fund inflows (the INDIVIDUAL INVESTORS' decision).
So far, what I'm saying is that the market is primed for a decline. I mean, major tops can take several months to form. Thus, it can be very painful to try to be bearish at a market top while it waffles around and while the media shouts loudly about major highs being broken -- even if they are broken by a few percentage points.
But let's zoom in to a 6-month chart of the Russell 2000. I focus on the Russell 2000 because it's a small cap index and small caps tend to reveal a lot near market tops, as institutions FIRST exit the smaller (higher risk) companies before exiting the big (established) companies. One reason is volatile fundamentals (smaller companies are harder hit by economic turbulence), and another is because smaller stocks trade on lighter volume.
When institutions want to sell smaller stocks, it's easier to seriously knock down the prices, making the exit price much less appealing. Thus, it's even more important for institutions to "sell into strength" (when there is demand) for smaller stocks. When we see bigger stocks performing well while smaller stocks are not, it's a big sign that institutions are unloading their positions to the individual investor, hyped on the promise of high long-term returns.
There are many things that tell us institutions are selling into strength. One is the high volume on the down days and low volume on the up days. In fact, I didn't mark it, but notice how the volume bars at the lower right part of the chart steadily decline as the market has advanced. This after fierce selling throughout 2013 -- a year touted as having the strongest first quarter since blah blah blah.
But also take a look at the RSI (bottom), a momentum indicator used to spot bearish and bullish reversals.
"Negative divergences", which are known precursors to bearish reversals, are seen all over the place. There are divergences within divergences, which I tried to make clear with the red, blue and green lines. Higher highs in the stock market are met with lower highs in the RSI.
You might also notice a consolidating price pattern with lower highs and lower lows. I also drew black lines showing a triangle forming. Now, triangles can either be continuation patterns or reversal patterns. So although the market is in the upper end of its trading range with a likely downturn ahead, it's definitely possible that the upper (black) line can be penetrated with a stock market breakout.
If that does occur, it would be a pretty big sign of strength in the face of all of this bearish action, and would imply higher prices are ahead.
HOWEVER, that doesn't take away from the FACT that institutions are selling out of the stock market as we have seen, clear as day, in the price volume action.
Getting back to the RSI...
We looked at the DAILY RSI, which can be found on a DAILY chart. But that's an intermediate-term indicator, as we wanted to zoom in to the intermediate-term picture (weeks to months). But this article started out discussing the long-term (months to years) returns that are used to bait individual investors to plunge a chunk of money into the stock market (often creating some demand for the institutions to sneakily sell into).
So let's look at the WEEKLY RSI which is found on the WEEKLY chart. At the bottom of the chart, you can that see the RSI oscillates from the top to the bottom. When it moves above the 70-line (where you can see it turns red), it's considered overbought (not to be confused with "over"). When it moves back below 70 it's considered a sell signal.
It's important to note that no indicator is perfect, which is why we must focus on the cumulative evidence provided by several indicators. Also note how overbought sell signals in the RSI were seen months before the absolute top -- the market moved a bit higher for a few months.
But the takeaway here goes back to the beginning of this article. Stocks should be SOLD here. If not, they should be hedged by using options.
This week is almost sure to be a big week. We have the Fed Meeting as you read this. Tomorrow you have the ISM Manufacturing Index reading (an important monthly number), you have the FOMC minutes, international trade numbers Thursday and the monthly Employment Situation on Friday.
Markets can tank or they can spike higher. Neither scenario changes anything I have said here.
If I owned bullish positions I'd be selling them. Or I'd be selling half of them at LEAST and selling more as I see more strength. Institutions are currently selling into strength. What are YOU going to be doing?
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An internationally respected authority on options, 9-year Wall Street veteran, and co-founder of Institute for Individual Investors, Chris Rowe spun out profitable trades for his Trend Rider members for 7 years, ending with his retirement in 2012. While most professionals consider an options trader who is right on 3 of 10 trades to be very good, Chris was right on the majority of his trades! Now, through his weekly "Technical Tuesday" Tycoon Report articles, Chris Rowe helps hundreds of thousands of investors across the globe, demonstrating the benefits they'll realize by taking a dispassionate, business-like approach to both stock and options trading. In his thorough and detailed, yet easy and accessible courses, you'll learn directly from Chris how incredibly easy it is to consistently make money - in bull markets, bear markets and flat markets - when you use a proven system for trading success. |
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