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The Magazine Cover Indicator, April 2013 - will it prove a great sell signal once again? |
A Four-Legged
SELL
A rare sighting has just been made of that most unwelcome of creatures, the Four-Legged Sell.
A secretive animal, it tends to appear just as investors in the world's stock markets have begun popping champagne corks. In fact it can be relied upon to rear its ugly head only when the stock market is hitting new highs and everything looks great. Which is just as it should be.
Since Santa swung in at the end of 2012 and gave bulls their Nice Little Christmas present, my finger has periodically hovered and twitched over the sell button, yet the buy signal I gave at my last update on November 13th has stood. Meantime, the rose-tinted crowd has enjoyed a Nice Little Rally - to all-time highs in the Dow Industrials Average and S&P500.
On the climb however, signs of exhaustion have been steadily building. These now suggest that the indexes need to take a breather, or fall back significantly, even if they have another leg higher yet to climb.
I am not gifted the heavenly foresight to know precisely how long or deep this breather will be, but the four groups of technical indicators I use have relatively long histories and the charts do show that, when they fire their sell signals simultaneously, significant trouble - and by significant I mean the kind you'd rather not stick around for if you're long - is likely heading our way.
SENTIMENT says... SELL
I start with the king of sentiment analysis SentimentTrader, and his ultra-reliable amalgam of numerous real-money gauges, the Smart/Dumb Money Confidence Index.
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| Source: SentimenTrader.com Smart / Dumb Money Confidence ('Dumb Money' flows are a contrarian indicator) |
When 'Dumb Money' confidence hits 60%, or the spread between Smart and Dumb money hits 25%, an environment of excessive optimism exists and, historically, US stock indexes have seen a correction. Here is the long term chart:
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| Source: SentimenTrader.com |
This state applies until one or other gauge moves to 'excessive pessimism' levels, as shown by the green horizontal lines.
Sentiment signals tend to be first to fire among the four groups, and this one rang its gong in February. That is why I rely on three other real-money sentiment guides to refine my timing, only after an environment of 'excessive optimism' has been firmly established by the indicator above. They are the Stock/Bond Ratio, and the CBOE's Equity & Total Put/Call Ratios. If just one of these fires a sell or warning signal, sentiment overall is said to be on a sell:
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CBOE TOTAL PUT-CALL RATIO |
It's worth noting that the Equity P/C Ratio and Stock Bond Ratio are giving mixed messages, although they have proved more susceptible to whipsaws amidst the latest market volatility. If all three move back to a 'buy' the signal will be negated, but right now the signs from sentiment are clearly negative.
BREADTH says... SELL
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Nasdaq Net New Highs |
I know of no other stock market indicator with as reliable a track record as this. Breadth is at an extreme, and until a buy signal is recorded (not shown) the stock market rises strictly on borrowed time. It needs to correct, and it will - almost certainly when the fewest number of people are ready for it. With the latest euphoric reaction rally, that time could be now.
VOLUME says... SELL
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NYSE Volume Volatility Indicator |
Volume - what a lot of guff is talked about it. Bears started complaining about the 'low-volume rally' almost on day one of this bull market, and after more than four years and 100% of stock market gains they're still complaining. This is the only way I've found to time longer-term volume data objectively - by measuring its volatility. The explanation is on the chart (please open in a new tab / window and zoom in to read in its full glory). Bottom line for this indicator is clear - historically speaking, when volatility gets up off the floor, it's time to check the exits.
MOMENTUM says... SELL
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Primary & Secondary Momentum Sell Indicator (RSI / PPO) |
This is designed to pick up divergances in either of two momentum indicators set to different timeframes. A secondary sell signal from RSI fired on April 23rd. This is the shorter-term gauge of the two, and tends to identify moderate pullbacks when the longer-term trend is still roaring higher - one reason why, right now, I'm not convinced we've yet hit a long-term top. It's an indicator I've charted right back to 1982,* and while whipsaws are not uncommon it is generally unwise to ignore the signals, particularly when there is...
CONFLUENCE
The probability of a correction occuring after each signal individually is, as you can clearly see, not insignificant. Each indicator however has its quirks and will occasionally give a false or early signal.
By waiting patiently for the whole four-legged creature to appear we can eliminate many of these (although, naturally, not all), substantially reducing the chances of being whipsawed if we decide to go short into a correction. The fact that each indicator has caught most, if not all, major corrections also means there is minimal likelihood of missing a move completely.
With the above set of signals, my bias now moves to a sell. Confidence has to be tempered somewhat by the febrile state of the sentiment indicators and an unconvincing divergance on the momentum chart. But that's what objective indicators are for, to eliminate errors through second-guessing by chin-strokers like me. Any alterations to this outlook will be updated immediately on Twitter, with any major revision posted here.
My suspicion, for what it's worth (probably not much), is that we're in a consolidation pattern which will take us sideways-to-modestly lower before a final surge brings new highs, a major top, and truly definitive sell signals in a few months time.
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* Momentum Sell Signal history:
