Clouds Gather Over Wall Street as Possible Correction Looms

Clouds appear to be gathering over the market and yesterday’s action may have been the first sign of a looming correction of some degree. 

The major equity indexes closed lower Wednesday with negative New York Stock Exchange and Nasdaq internals. NYSE volumes were rising as the Nasdaq’s dipped from the prior session. But much more was happening under the hood.

Charts and Technicals

Multiple cautionary technical events occurred in the charts, while cumulative market breadth turned bearish. And while some of the McClellan overbought/oversold oscillators are now oversold and suggesting a short-term bounce, our concerns regarding overly bullish investor sentiment and very extended forward valuation of the S&P 500 based on Bloomberg’s forward 12-month earnings estimates continue to be disconcerting. 

The major equity indexes closed lower yesterday with broadly negative internals as most closed near their session midpoints. As a result, several cautionary technical events were registered on the charts. 

The S&P 500, Dow Jones Transports, mid-caps and Russell 2000 all closed below support. Additionally, the Dow Jones industrials, Nasdaq composite and Nasdaq 100 closed below their near-term uptrend lines, shifting their trends to neutral from bullish while the Russell 2000 turned bearish. Only the S&P and Dow Transports remain in near-term uptrends. Cumulative breadth didn’t help with the advance/decline lines for the All Exchange, NYSE and Nasdaq turning bearish. Bearish stochastic crossover signals were also generated on the S&P 500, Dow Jones, the Nasdaq composite, and Nasdaq 100.

The data remains largely neutral, but we still have our concerns regarding investor sentiment and valuation.

Also:

• The one-day McClellan overbought/oversold oscillators are oversold for the All Exchange and NYSE, suggesting a bounce, while the Nasdaq’s is neutral (All Exchange: -57.98; NYSE: -89.1; Nasdaq: -39.76).
• The percentage of issues trading above their 50-day moving averages, a contrarian indicator, dropped to 62% staying neutral.
• The Open Insider Buy/Sell Ratio rose to 32.0, but stayed neutral, as well.
• But the detrended Rydex Ratio, a contrarian indicator, at 1.04 is bearish as the leveraged exchange-traded fund traders are leveraged long after a significant rally.
• Additionally, this week’s American Association of Individual Investor Bear/Bull Ratio, another contrarian indicator, remains bearish at 0.53 as the crowd is overly bullish.

• The Investors Intelligence Bear/Bull Ratio also remains bearish with bulls overwhelming bears at 21.3/55.7. They suggest there is an excess of bullish expectations currently.
• Finally, valuation remains a concern. The 12-month consensus earnings estimate for the S&P from Bloomberg slipped further to $255.08, leaving its forward price-to-earnings of 22.7 well above the “rule of 20” ballpark fair value at 15.8, as has been the case for the past several months. We believe this premium still presents some risk.
• Its earnings yield is 4.4%.

The Buck and Treasury 

The 10-year Treasury yield rose to 4.24. Support is 4.10% with resistance at 4.25%. Its near-term trend is bullish. The U.S. Dollar, via the Dollar Index Bullish fund UUP, closed higher at $29.29. Its trend is bullish with support at $29.02 and resistance at $29.32. 

Bottom Line

Time to get cautious regarding the market’s near-term prospects as the probabilities of a correction have increased.