Think the Correction Is Over? Show Me the Evidence
All three of our sentiment indicators are bearish as the 'herd' is all on the bandwagon.
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Friday's market was likely encouraging to many bulls after a few rough days for the large-caps. But what should we take from it?
There were no changes in their near-term trends, which are a mix of bearish, bullish and neutral implications.
Meanwhile, our concerns regarding market overvaluation and an excess of bullish investor sentiment continue to cause concern regarding the market’s near-term prospects.
At this point, we suspect the recent bounce in the market is one of testing resistance within an ongoing correction.
Bounce Leaves Mixed Chart Trend Unchanged
On the charts, all the major equity indexes closed higher Friday with positive NYSE and Nasdaq internals on lighter trading volumes.
There were some notable technical events registered as the DJIA, Dow Jones Transports, MidCap 400 and Russell 2000 (see below) closed above resistance as the S&P 500 closed back above its 50-day moving average.
The action, in our view, was one supportive of our opinion of a rotation from the mega-cap stocks into the smid-caps as discussed here previously.
Of higher importance, none of the index trends were altered as a result of the gains. The S&P, Nasdaq Composite and Nasdaq 100 remain bearish with the Dow Jones Transports and DJIA bullish and the MidCap and Russell neutral.
Cumulative market breadth did improve, however, from bearish to neutral for the All Exchange NYSE and Nasdaq.
No stochastic signals of import were generated.
Warning Signals
The data, in our opinion, are still sending some warning signals.
The 1-Day McClellan Overbought/Oversold Oscillators are still neutral and not oversold (All Exchange: +40.02 NYSE: -2.66 Nasdaq: +41.66).
The percentage of S&P 500 issues trading above their 50-day moving average (contrarian indicator) rose to 69% and is also neutral.
But the detrended Rydex Ratio (contrarian indicator), below, remains bearish at 1.03, as the typically wrong leveraged ETF traders remain overexposed and leveraged long. We still need to see some fear on their part.
That leaves all three of the sentiment indicators bearish as the “herd” is all on the band wagon.
Last week’s AAII Bear/Bull Ratio (contrarian indicator) turned bearish at 0.50 as the Investors Intelligence Bear/Bull Ratio (contrary indicator) stayed bearish at 16.7/63.6 as bulls continued to outweigh bears by a wide margin. There is no “wall of worry” to climb.
The Open Insider Buy/Sell Ratio is neutral at 30.9.
Leveraged ETF sentiment at 2.6% is neutral.
Valuation Remains a Concern
The 12-month consensus earnings estimate for the S&P 500 from Bloomberg dropped to $252.27 per share. However, that leaves its forward P/E multiple of 21.6x still well above the “rule of 20” ballpark fair value at 15.8x. This almost 600-basis point premium is significant.
The S&P's earnings yield rose to 4.62%.
The 10-Year Treasury yield slipped to 4.2%. Support is 4.20% and resistance at 4.3%. Its near-term trend is bearish.
The U.S. dollar, via the UUP ETF, closed lower at $28.82. Its trend is neutral with support at $28.70 and resistance at $28.87.
Bottom Line
We need to see more evidence that the current correction has completed itself before getting encouraged. Caution remains appropriate.
We continue to focus on protection of capital by honoring sell signals on individual names while staying very selective on the buy side.