Wednesday, 13 February 2013

Nowhere to go but down?

About John Nyaradi

 John Nyaradi is Publisher of Wall Street Sector Selector, a financial media site focused on news, analysis and information about exchange traded funds and global financial and economic developments.
John's investment articles have appeared in many online publications including MarketWatch, Trading Markets, Money Show, Yahoo Finance, Investors Insight, Fidelity, ETF Daily News, iStock Analyst and his interviews have appeared on MarketWatch, Yahoo Finance's Breakout, National Business Talk Radio, Sound Investing, and The Index Investing Show. His book, "Super Sectors: How to Outsmart the Market Using Sector Rotation and ETFs", is included among the Years Top Investment Books in the 2011 Stock Trader’s Almanac.
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By John Nyaradi
After a sharp New Year's run-up, major U.S. stock indexes have stalled at significant resistance levels and multiple fundamental and technical indicators suggest that perhaps there is now nowhere for equities to go but down.
Over the last couple of weeks, we've all read a steady stream of overly-bullish headlines and listened to media commentators celebrating Dow 14,000 and the possibility of a new, eternal bull market. However, overhyped headlines and a series of fundamental and technical factors point to the possibility that, as usual, such enthusiasm tends to mark market tops rather than bottoms.
Starting with technical indicators, a chart of the S&P 500 dating back to 1998 demonstrates how the index has established a triple-top over the period from 1998 through the present. This is an enormous resistance level and one that will need to be convincingly broken before one can declare eternal life for the bulls.
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A second chart that gets little attention is the chart depicting the percentage of S&P 100 stocks above their 200-day moving average.
This chart presents a fascinating study of buying habits in the S&P 500, and it's easy to see that we're now also at a quadruple-top level in this data series. With 87% of the stocks trading above their 200-day moving average, one could argue that the market has passed a saturation point and that there is little upside room for U.S. equities at the current time.
If past is prologue, today's lofty level on this chart could easily lead to a decline of some magnitude as it has in the past. A number of these have been quite significant while others have been more benign.
Of the major declines depicted, the slowest swoon was in late 2007, when it took six months for the S&P to slide 17%. In mid-2010, it took only three months to make 15% disappear, while in mid-2011, the market declined 18% over four months.
In addition to technical factors pointing to an overbought market, a number of fundamental factors are also flashing red.
Extraordinarily-high levels of bullishness have recently popped up in various investor sentiment gauges. The American Association of Individual Investors Sentiment Survey results for Feb. 6 were 42.8% bullish — down 5.3 from the previous week, however, still above its long-term average, as retail investors expect the bull to continue its run.
Bullishness among financial advisors appears to be even more elevated as The National Association of Active Investment Managers' (NAAIM) weekly survey shows a reading of 94.06 for the week ending Feb. 6 compared to last quarter's average of 70.53.
With recession beginning to grip Europe, a source of a significant percentage of S&P 500 profits, one must to look to Germany, Europe's strongest economy, as the "canary in the coal mine," and unfortunately, the canary might be about to croak.
Until recently, the euro zone's largest economy has exhibited resilience in the face of a recession which is likely to afflict the other 16 member nations through the end of 2013. Unfortunately, both the DAX Index and the iShares MSCI Germany Index ETF (EWG) have taken a turn for the worse since the beginning of February. In fact, the both the DAX and the iShares MSCI Germany Index ETF have nearly completed the formation of head-and-shoulders patterns, signaling the possibility for further declines. Read European Stocks Decline As Euro Advances
Other fundamental factors that must be considered is the recent fourth-quarter GDP estimate of -0.1% for the United States and the upcoming sequestration debate and the draconian cuts scheduled for March 1. We all know that two consecutive quarters of negative GDP is the official definition for recession, and no matter what happens in this discussion between Congress and the White House, it's hard to see a positive outcome.
Sequestration cuts are widely forecast to trigger a significant stock market decline and even recession, while even modest cuts to government spending will inevitably be a further drag on the U.S. economy. Another option is "kicking the can down the road" yet again, but even that path has potential peril, as ratings agencies will likely frown on such a move and interest rates could rise, making the towering mountain of government debt even more difficult to service.
Adding it all up, it's very difficult to make a compelling case for higher stock prices ahead over the short term. Of course, "Mr. Market" always tries to inflict as much pain on as many people as possible, so everything is always subject to change. However, for today, Wall Street Sector Selector remains in "Yellow Flag" status, expecting consolidation or correction ahead.
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