I stand conflicted. The trend follower in me wants to trust the current market and believe we go higher from here while keeping in mind that based on historical price action from 1928 through 2008, equities have finished out the year on strength in election years. There are also numerous commentaries about about how this has been such a hated rally and how hedge funds and individual investors alike have not participated, giving a bullish siren if they decided to cry mercy and jump on the equity bandwagon.
But the other part of me sees the signs of cracking that are occurring in various parts of the equity market. These cracks are what I want to address tonight.
When you look at different inter-market relationships there is a strong underlying tone of traders staying extremely cautious with their equity allocations.
For example, below is a chart of the ratio between consumer discretionary and consumer staple ETFs (green line). When the line is falling, as it has been for weeks, it means consumer staples are outperforming consumer discretionary. Which is often read as a sign of traders keeping their beta low while still holding equity exposure to the retail space.
Next up is a chart I use to keep an eye on buying (green line) and selling (red line) pressure. I last looked at this as a bullish sign of traders shifting to ‘risk on’ back in late-June. As you can seen, buying pressure has been steadily making lower highs and lower lows since July. The confidence behind the increase in equity prices has slowly been eroding. However, not at such a pace to stop the rally in its tracks. It’s also important to notice that this has been occurring for months while price marches higher, so we can’t view this chart in a vacuum.
Finally, a weekly chart of the S&P 500 with the Money Flow Index in the bottom panel. Once trading finished on Friday, the MFI indicator closed below 80 on a weekly basis. We have yet to see equity prices sustain their strength (at least for a few weeks) when this has happened in the past few years. Now it’s important to notice that the break below 80 was not grandiose, the indicator presently sits at 79.80. But a break is a break.
So working in the bulls favor is the lax Fed policy with QE3 flowing through the capital markets, the constant hint of another European bailout, the under-invested consumer, the performance-chasing hedge funds, and finally, the election year cycle.
For the bulls, we have the charts mentioned above.
Where do we go from here? It’s anybody’s guess. However, in times like this, confirmation can be key and sticking to your trading plan is critical. The trend is still positive and that’s enough of a reason for many to hold steady.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+.
