Market Repeating 10 Warning Signs of a Major Top
Ron Coby & Denny Lamson NOV 02, 2010 9:00 AM (edit: i am posting this for quite near term Bears to re-inforce their view.i remain cautious until SPX 1221(It would be a POTENTIAL DOUBLE BEAR SIGNAL a double top from our most recent major high and also at the Fibonacci Retrace of 61.8)---then i think we are going DOWN.Max)
We have the exact same warning signs today that we had back in April 2010 before global markets imploded. We're also at the same exact moving average that stopped the last bull charge.
Here we are again on the S&P 500. We're right at the declining 200-week moving average just like we were in April 2010. In mid-April we put out a piece titled 10 Warning Signs of a Major Top. Two weeks later, we put out our sell short report when our timing indicator went on a sell on the S&P 500. Then, four trading days later, we all experienced the now famous “flash crash,” followed by six months of incredible volatility. Today’s piece is similar to that mid-April article we put out in that we're seeing the same warning signs (but again no signal to get short). In fact, we're going to list those 10 warning signs that we wrote about in mid-April and show you the similarities to today. This should give you some appreciation as to why we recently advised everyone to get to cash before all the widely anticipated good news on the election and QE2. It's possible that much of the good news (if not all of it), is already priced into the market. Anyway, here's the piece we did in April 2010 along with the comparison to today.
10 Warning Signs for Another Correction or Even a Major Top Like 2007:
1. Rising oil and gold prices are pressuring bonds and pushing interest rates higher. This could spell trouble for both the economy and the stock market.
TODAY: Gold has exploded even higher signaling the Fed is getting what it wants, which is to win the war on deflation by creating asset inflation. High gold prices and a steadily rising Treasury Inflation Protected Bond ETF (TIP) are both indicating the Fed is creating inflation. However, when you mix in the deflating economy it's more like stagflation. Oil prices have remained stubbornly high and that will continue to put downward pressure on the economy and on consumers. Bonds once again are being pressured to the downside.
2. The weekly Full Stochastic is topping, warning that prices are high and could reverse at any time.
TODAY: The weekly and daily Full Stochastics are again both topping.
3. Like 2007, the weekly MACD is curling over from extreme overbought levels.
TODAY: The Daily MACD is topping but the weekly MACD is neutral.
4. The S&P 500 is fast approaching its declining 200-week moving average (1225) as well as the 0.618 Fibonacci retracement (1227) of the entire collapse.
TODAY: Back in April we felt that sophisticated traders would trade against those two key price levels. Here we are again. The S&P 500 failed at the declining 200-week (as we predicted) and massive downside volatility followed. Today the S&P 500 sits right at that declining 200-week moving average once again, so let’s watch and see if that key moving average again becomes major resistance. The Dow Jones Industrial Average, the Nasdaq, and the Russell 2000 are all above that key moving average, but they haven’t yet crossed the April 2010 highs. Those April highs are key resistance areas for the S&P 500, DJIA, Nasdaq, and the Russell 2000 to try to overcome.
5. Cash is at the lowest levels since 1987 and 2007 at 3.5%. This means mutual funds are all in and they will have little ammunition to support the next series of dips or severe market correction.
TODAY: Cash has just hit a new record all-time low at 3.3%! Mutual funds are in an even more precarious position if markets should double top and crash again. Fortunately, mutual funds have the Fed to bail them out time and time again.
6. Recent sentiment surveys are showing that bears are becoming an extinct breed on Wall Street. Investors Intelligence showed only 20% bears last week. The bulls are certainly running wild on Wall Street.
TODAY: Bears were reported to be 22% last week so they have once again become extinct. Bulls on the AAII polls were reported to be over 50% so the bulls are again running wild on Wall Street. Again, this is another bearish sign.
7. The Volatility Index is at very low and dangerous level of 16.78 now and is warning that investor complacency is very high. A low VIX is not a good timing indicator but simply another warning sign that a significant top could be approaching. We're now at the exact same VIX reading that we had in early October 2007, right at the top.
TODAY: The VIX is at 21.20, which is the same level it was at in September 2008 before the market crashed more than 50%, so it’s dangerously low again. The iPath S&P 500 VIX Short-Term Futures ETF (VXX) is hitting all-time lows. Corrections and crashes start when there's no fear in the marketplace. 8. The DJIA is forming a possible right shoulder on the monthly chart. This could be the mother of all head-and-shoulder tops. Giant head-and-shoulder tops are also forming in the Russell 2000, the Wilshire 5000, and other global markets on the monthly charts as well. These are textbook head-and-shoulder tops if completed.
TODAY: That right shoulder is still in place. If the markets were to fail and reverse next week, we would have clear double tops on all the charts. Nasdaq hit a closing high of 2535 in April and on October 29, 2010, hit a high of 2517 (double top?). The DJIA closed at 11,258.01 and hit 11,247 last week (double top?). The S&P 500 closed at 1219.80 April high and hit 1196.14. All of these could turn into major double tops, but the market will need to have a reversal next week to complete these double tops. Closes below 2435 on Nasdaq Composite, 1170 on S&P 500, and 11,000 on DJIA would likely start that process.
9. The market-leading Index, Nasdaq, is now at the exact same RSI reading as in early October 2007 of 74.42. The RSI then went to an extreme low reading of 21.95 on the daily chart in October 2008 and 29.79 at the March 2009 lows. The RSI can go a lot higher and you only have to look at the 86.74 RSI reading in early 2000 for evidence of that. However, this is a high and potentially dangerous level on the RSI just like it was in October of 2007.
TODAY: The RSI is 71.72 on Nasdaq, so it’s close to the level we wrote about before the market topped and the flash crash started.
10. And finally, the old Wall Street saying may hold up well given all these early warning signs: “Sell in May and go away.”
TODAY: This old Wall Street adage would have saved investors a lot of grief and pain had they followed it. The frightening flash crash for long-only investors would have been avoided by selling on May 1. Today we're entering a seasonally bullish period. However, markets are often weak in September and bottom in late October. That has certainly not been the case in 2010 because the Fed got the “QE2” word out to get stocks rocketing higher in front of this week’s supposedly good news QE2 event. Also, keep in mind that five out of the last seven midterm elections have seen stocks get hit immediately after the election.
Finally, here's how we ended that mid-April piece:
In summary, there are many additional warning signs of an imminent top. High oil prices have historically led to recessions so prepare for the possibility of a double dip. When the Fed is forced by the bond market to hike short-term rates, tighten up the chin strap on your crash helmet. Put on all your other crash protection gear as stocks will reverse violently once the Fed starts jacking up interest rates. Get ready to hedge your long positions as the roller coaster approaches another peak. This next ride down could be the wildest ride since the one from the top in 2007.
Well folks, the S&P 500 crashed from 1219.80 all the way down to a low of 1010.91 on July 1. That was 17% on the S&P 500, 18.7% on Nasdaq, and 21% on the Russell 2000. We put out a piece on July 1 advising everyone to “sell the TWM inverse” and to cover all shorts because we felt “the invisible hand” of the Fed (now very visible) would come in to save the day. And that's exactly what they did and that was the day of the bottom. The market then became very hard to navigate as it had a series of powerful rallies and violent sell-offs. So here we are again, all the way back to the April 2010 highs. Now what?
First, the Fed has done its bubble blowing job again, so we want to recognize that and congratulate them. It has created all kinds of new asset bubbles. We see one in the US government bond market by the Fed's promise to monetize the debt and keep rates low for “an extended period of time.” And that bond bubble grew larger by its promise of more quantitative easing and the purchasing of more and more bonds. In other words the Fed is saying it will prop up bond prices artificially (creating a bond bubble) to prop up a weakening consumer and a near failing economy.
The Fed has also recreated bubbles in emerging and global markets (China, India, Hong Kong, Singapore, Brazil) and new bubbles in commodities across the board (except natural gas and lumber). Why is this happening? Investors everywhere are trying to flee the prospect of a weak or even a crashing US dollar as the Fed’s actions threaten to turn our currency into confetti. If the Fed announces another $1 trillion of quantitative easing next week (1,000,000,000,000.00) then investors may be correct in that fear. A close below 74.62 on the US dollar and our Grail will be on a confirmed compression sell on the monthly charts and the Fed will likely have a dollar crisis on its hands.
There are a few more things to worry about as well. Corporate insiders, the so-called smart money, are selling stocks at a furious pace. The sell-to-buy ratio is 3,177 to 1! But can we blame them really? The Nasdaq is up 99% from the March lows. The Russell 2000 is up over 100% and the S&P 500 is up 80% from the March lows. If you doubt the power of the Fed to move markets then never doubt them again. Like Marty Zweig famously said, “Never fight the Fed.” Truer words have never been spoken with the exception of “Never fight the tape.”
Another possible warning sign is the lower RSI on the daily charts with new cycle highs last Monday. This can often be a negative divergence seen at tops and is yet another warning sign. Like we need any more of these, but another bearish sign is that we have the same picture on our Grail timing indicator. We have a long string on momentum dots now like we did at the April highs (23 momentum dots now versus 30 at the April high). We have an even wider divergence taking place on the oscillators. What we don’t have yet is a sell signal but the setup is there for a reversal.
In summary, we have the exact same warning signs today that we had back in April 2010 before global markets imploded. We also have the same setup in our Grail timing indicator that we had back then. Most importantly, we're at the same exact moving average that stopped the last bull charge. Markets are stretched like a rubber band and ready to have a snap-back move. That snap-back move may not kill the bull in a “wave C down,” but it could be a painful correction nonetheless. This is the bear’s last stand. If we do rip this week and cross over the declining 200-day moving average on the S&P 500, and the April 2010 highs, then that would be a sharp knife through the heart of the bears. However, even if that bullish event happens, we'd expect a multi-month period of consolidation. We'll save that detailed analysis for a future report. Finally, we made both the warning call and the short call in April 2010. We're now making the same warning call, and if we get the sell signal as we did then, we'll make the big short call again as well.
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Ron Coby & Denny Lamson are the authors of the Grail ETF & Equity Investor newsletter. The Grail ETF & Equity Investor contains Messrs. Coby and Lamson's own opinions, and none of the information contained therein constitutes a recommendation by Coby, Lamson or Minyanville that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Messrs. Coby and Lamson will not advise you personally concerning the nature, potential, value or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. All information contained within the Grail ETF & Equity Investor newsletter is impersonal and not tailored to the investment needs of any specific person. Do not email Messrs. Coby or Lamson seeking personalized investment advice, which they cannot provide. Messrs. Coby and Lamson's past performance is not a guarantee of future performance and there is no guarantee that the suggested investments will have the desired results. The performance represented here is for informational purposes only, and should not be construed as an offer or solicitation of an offer to sell or buy any security. Please keep in mind that this Portfolio does not necessarily account for the different risk tolerances, investment objectives, and other criteria used by individual investors when making an investment decision. You are encouraged to conduct your own research and due diligence, and to seek the advice of a qualified securities professional before you make any investment.
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