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Investor Sentiment Is Cheerful, Which Makes Us Cautious

Let's look at why optimism and valuation have us guarded.

Oct 23, 2024, 11:10 AM EDT

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The major equity indexes closed mixed Tuesday with negative New York Stock Exchange internals, while the Nasdaq had negative breadth, but positive up/down volume. But we're getting a bit more cautious, as we'll explain below. 

Most index charts closed near the midpoint of their intraday ranges, as one index shifted to neutral from bullish as two of the market breadth indicators turned bearish. And while much of the data remains neutral, we are still seeing need for some caution as investor sentiment remains overly optimistic, while forward valuation for the S&P 500 based on Bloomberg’s forward 12-month earnings estimates remains very extended above ballpark fair value. 

The Charts and Technicals

We see sentiment as signalling a need for caution on technical front. Other items of note:

  • The mid-caps closed below their near-term uptrend line, shifting the trend to neutral from bullish as is the Russell 2000. The rest remain in uptrends.
  • Cumulative market breadth took another hit, suggesting the market’s foundation is weakening. The cumulative advance/decline lines for the All Exchange and Nasdaq turned bearish with the NYSE’s staying neutral.
  • Also, the Russell 2000 registered a bearish stochastic crossover signal.
  • The one-day McClellan overbought/oversold Oscillators are still neutral for the All Exchange and Nasdaq with the NYSE’s now oversold (All Exchange: -24.82; NYSE: -55.18; Nasdaq: -6.82).
  • The percentage of SPX issues trading above their 50-day moving averages, a contrarian indicator, dropped to 64% staying neutral.
  • The Open Insider Buy/Sell Ratio dipped to 29.0, staying neutral, as well.
  • But the detrended Rydex Ratio, a contrarian indicator at 1.06, is bearish as the leveraged exchange-traded fund traders are leveraged long after a significant rally.
  • Additionally, this week’s American Association of Individual Investors Bear/Bull Ratio, a contrarian indicator, remains bearish at 0.53 as the crowd is overly bullish.
  • The Investors Intelligence Bear/Bull Ratio, a contrary indicator, 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 SPX from Bloomberg slipped to $255.22, leaving its forward price-to-earnings of 22.9 and well above the “rule of 20” ballpark fair value, as has been the case for the past several months, at 15.8. We believe this premium still presents some risk. Its earnings yield is 4.36%.

Treasury and the Buck

The 10-year Treasury yield rose to 4.2% and above resistance. Support is now 4.10% with new resistance at 4.25%. Its near-term trend is bullish. The U.S. dollar, via the Dollar Index Bullish fund UUP closed higher at $29.19 and above resistance. Its trend is bullish with support at $29.02 and new resistance at $29.32.

The Bottom Line

In conclusion, the weight of the evidence suggests it’s time to be more cautious regarding the market’s near-term prospects.