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Friday, May 27, 2005

Stock Market

.The final piece of the bullish puzzle was the market's breaking out over resistance ($SPX over 1182, for example). This also included penetration of the 50-day moving average, which had contained all previous rallies since the March top. Since then, the push upward has continued with only a minor pause. Further resistance (at 1190, basis $SPX) was overcome, and now it appears that there is very little standing in the way of a challenge of the yearly highs at 1220 or above ($SPX).

The equity-only put-call ratios turned bullish at literally the exact bottom. While they were the only indicator to be bullish at that time, they were joined by the others within days. These powerful sentiment- based indicators continue to remain bullish, as can be seen from Figures 2 and 3. As long as the line on the put-call ratio chart is declining, it is on a buy signal. Furthermore, these latest buy signals came from an extreme level (high on the chart), which often indicates a stronger-than-usual signal.

Market breadth has been flighty, at best. Oscillating back and forth with nearly every market move, there have been a series of buy and sell signals that have not been particularly helpful. Recently, breadth slipped again and gave sell signals. We are not terribly worried by these sell signals, as long as they are the only ones.

Volatility ($VIX) has continued to make new relative lows. We don't expect to see it go all the way back down to 11, but this downward trend is bullish. In fact, it penetrated what had looked to be a budding uptrend in volatility, returning things to the low-volatility, bullish scenario.

Before summarizing, I'd like to discuss the "conventional" wisdom that says this market is so overbought, it is due for a major correction. I don't agree. Let's examine the indicators in this light. Breadth was overbought, true, but certainly not extremely overbought. Meanwhile, it is no longer overbought after two mild days of pullback in the market. Equity-only put-call ratios are not overbought; they'd have to be at the bottom of their charts for that to be true. In fact, they were extremely oversold and haven't reached anywhere near an overbought state yet. Next, consider volatility ($VIX). It is near 13, which is about the average for this year. If it fell to 11, it would then be overbought, but it's not there and hasn't been. So, since none of these indicators is or was overbought, what these traders must be talking about is the action of the major indices themselves. In other words, the fact that the market rose so strongly and uniformly for about a week and a half has produced this "overbought" talk. Frankly, $SPX was up much more strongly than this just a few short months ago -- October and November last year. Note the circled portion of the $SPX chart in Figure 1. So, there is really no reason why the market can't continue on upward at this time.

Overall, we want to continue to view this market as bullish until it either falls back below 1180 (basis $SPX) or some of the other indicators turn bearish. None of those conditions is at hand, so expect higher prices.

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1 comment:

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