Home > Uncategorized > Equity Markets Look Vulnerable – Long and Short Term

Equity Markets Look Vulnerable – Long and Short Term

Complacency
has reigned supreme

During
the past few weeks there has become an alarming increase in the
amount of data demonstrating complacency comparable to prior
significant turning points. Lately, I have been getting this feeling
of deja vu as the market environment is becoming reminiscent of
mid-2007.

In
my view, now looks as good as any time since spring of 2009 for
investors to demonstrate some vigilance and pare back on longer-term
holdings. For short-term traders, this would be a good time to get
your mind right and be prepared to take advantage of what will likely
become a much more volatile and exciting trading environment.

Here
are some bullets supporting the mid-2007 comparison:

  • Several
    different types of Put/Call ratios have moved to multi-year
    extremes.
    Jason Goepfert at
    www.sentimentrader.com
    says “
    Large
    traders spent 43% of their volume buying call options, the 2nd-most
    of any week since the year 2000 (March 10, 2000 was the highest, at
    43.1% of total volume).” THIS WAS ABOUT TWO WEEKS PRIOR TO PEAK IN
    THE TECH BUBBLE!.

  • Unprecedented
    reach for yield by debt investors.
    According to Bloomberg, junk
    bonds are making up the biggest share of corporate debt sales on
    record as investors on an economic rebound snap up securities from
    even the first-time issuers. High-yield bonds yield an average of
    8.59%, the lowest since October 2007. As of April 9th,
    the spread between high-yield and treasuries has fallen to near the
    lowest level since December of 2007 – 5.83%.

  • Investor
    Intelligence Bull Ratio recorded 73.2% as of 04/09/10.

    A reading which is near the upper 90 percentile of bullishness.

  • Intermediate-Term
    Indicator Score at historical levels
    (The ITI Score was
    developed by the before mentioned Jason Goepfert.) Thursday's score
    of 58% has only been achieved once during its 10+ years in
    existence.

Click on chart to make HUGE
ITI SCORE

The
technical landscape
of the major indices further supports the timing
of these significant readings in sentiment.
These bullets are for the S&P 500 Cash Index:

  • Completion of a classic Elliot Wave pattern ( 3 Impulsive and 2
    Corrective waves)

  • 61.8%
    Fibonacci retracement level going back to the 2007 peak looms just
    above our heads at 1226.

  • Retracement
    back to the pre-panic selling level surrounding the Lehman debacle.
    Often times panic moves, regardless of the time frame, will at some
    point be fully retraced. This seems to be largely due
    to the fact that these moves are on the heels of irrational behavior
    acting similarly to large gaps, a gap in rationality if you will.
    Why is this bearish? Because, once “filled” it becomes a point
    of resistance. (Same rules apply to parabolic moves and the subsequent crash-n-burn.)

Click on chart to make HUGE

SPX CHART

On
a longer term basis we will still need to be patient and see how
events unfold heading into summer before further developing a longer
term thesis. If it is a significant trend change we are looking at
then it will be a bit tricky. Market tops tend to be more difficult
to identify than bottoms due to the fact that they are processes and
not events. What sometimes looks like a top can eventually turn out
to be a continuation pattern. Remember, while there is plenty of
evidence suggesting we could be on the cusp of forming a long term
top, in 2007 it took several months before the change in trend became
clear.

Looking
out the next 1-2 weeks

Until Friday there had been little to no reprieve for the bears for over two months. The strength of the rally and
the 'ladder-like' price action in the indices left little reason to
be a seller of equities. Friday's SEC allegations against Goldman
Sachs however, looks like a promising catalyst to begin a near term
decline and the potential for an upstart in trading volatility.

Friday's
action put in what I like to call a “Dagger Day”. This is a day
in which the market knifes lower by at least 1.5-2% shortly after
reaching a multi-week/month high with a volume ratio heavily skewed
in favor of the bears – Friday's down volume trumped the up volume
by a healthy margin of over 12 to 1 and near the lows of the day it
was around 20 to 1. Friday's sell bar also put the channeling
“stair-step” rally, which began on February 5th, in
serious jeopardy. (See chart above).

For
the near term, probability has become skewed in favor of the bears
and as such I will be looking to short rallies in Index futures as
they begin to stall and fade lower.

Key
levels in the S&P 500 Cash Index:

  • 1183
    – 20 day EMA

  • 1172
    – 200 period EMA on 60 minute time-frame

  • 1156
    – 50 day EMA

  • 1150
    – Jan 19 high/breakout level

  • 1143
    – 50 day SMA

In
conclusion, with the before mentioned sentiment data, chart
landscape, and near term headline risk probability favors at least a
highly anticipated up-tick in volatility creating more two way trade
which is great news for all of us sitting on a trading desk.

Until
next time, I wish you all the best of luck trading and remember to be
flexible as markets are never wrong, but traders are!

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