Benefit of the Doubt Goes to the Bulls

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I was out of town last week on vacation. So, I will get right to the facts in a short but sweet missive today. The market appears poised to go higher from these levels. This is not the call for an all-out bull run, but the weight of the evidence favors the bulls, slightly, based on recent action. 

There has been a steady stream of negative headlines over the past several weeks. These negative headlines have led to very negative investor sentiment. According to the American Association of Individual Investors (AAII) survey, the percentage of bulls recently dropped to an extraordinarily low reading of 22.2%. This indicator has been extremely accurate when used as a contrary indicator. A very low reading is good news for the bulls. The market has advanced against a constant wall of worry. The economy is slowing, Europe is imploding, and earnings are going to be awful—sound familiar? All of this news is out there and the market continues to go up. News gets discounted once. The market knows everything. It is not the news that counts, but the reaction to the news that is in important. 

From my point of view, a little more than 50% of the stocks in the S&P 500 are in sound shape technically, and there are many names that are in their own private bear markets. Do not try to bottom fish. Select names that are in sound shape technically.

There was a negative divergence back on the 19th of this month when the S&P 500 closed slightly above its resistance level and the other indexes did not. This set the market up for the pullback that extended into the middle of last week. As the market was sold off last week investors came in and bought the dip. The S&P 500 held above the 1324 support level, the Dow held above its 12,845 intermediate term support level and the NASDAQ held above support of 2833. The Russell 2000 broke below 773 support and its 200 day moving average. Since only one index gave way, a positive divergence developed, and the market roared ahead last Thursday and Friday. 

Where are we now? Just like the overall market the indexes are split. The S&P 500 and Dow closed above their respective resistance levels of 1382 and 12,980 but the NASDAQ and Russell 2000 failed to exceed their break out levels of 2990 and 822. If those two levels are not taken out over the next few days a negative divergence will develop and the next pullback should begin.

With the indexes all trading above their 50 day moving averages I suspect a pullback will be controlled. I don’t think the intermediate term support levels will be tested again like they were last week but here they are: S&P 500 1324, Dow 12,485, NASDAQ 2833, and the Russell 2000 at 765.

The top in the market roughly coincided with the top in oil prices. The top in oil came a little more than four months ago. As oil topped many economic numbers began to roll over also. We have begun to see some improvement in economic numbers. Housing has been an area of strength. Jobless claims came in better than expected last week. Numbers are either getting better or they are getting worse. Over the next several weeks I feel that we will see a positive change at the margin. When economic numbers are released I suspect we will begin to see numbers surprise to the upside.

Stay focused on the individual names you own or are considering owning. The recent trend has been for the market to sell off near the support levels I have given over the last few weeks and then a rush of buyers come in to take advantage of the pullbacks. The overall market appears to have moved to a buy the dip mentality.

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About Thomas J Smith CFA