Looking at the Four "Bull Market Checks": Trend, Momentum, Breadth, and Sentiment

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The Dow Industrials are flirting with the 20,000 level, but we haven’t seen a breakout above that psychologically important number...yet.

This time on Financial Sense, we spoke with Jonathan Krinsky, chief market technician at MKM Partners, about market direction and his four bull market checks that indicate we still have room to run.

Breakout Coming?

“After the run we had off the post-election lows, it’s not the worst thing to move sideways and work off some pretty extreme overbought conditions,” Krinsky said.

When we first made the recent highs, we had some of the most extreme overbought conditions in 25 years, he noted. If we break 20,000, which he thinks we will, that resistance level would turn into important support on the downside.

“What’s interesting about Brexit and the election is, those are actually the shakeouts that created the fuel to get us to new highs,” Krinsky said.

Four Bull Market Checks

There are four important checks for market direction, Krinsky noted: Trend, Momentum, Breadth and Sentiment.

Trend: One thing Krinsky likes to do is take price out of the mix and just look at the long-term moving averages of the S&P, namely the 10-month and 20-month moving averages.

Thes are very long-term indicators that don’t tend to flip very often.

For example, if we look back to the January-February period last year, we had the 10-month cross below the 20-month moving average for the first time in a while, Krinsky noted.

“In fact, the last two times we saw that negative cross over was entering the 2001 to 2002 bear market, and again in the 2007 to 2008 bear market,” he added.

Those signals, though infrequent, are to be respected, he stated. We did see a pretty sizeable move down into February last year with a 19 percent drawdown on the equal weighted S&P 500 and a 26 percent drawdown on the small caps. We also saw a lot of bear markets at the sector and stock levels.

“Even though it didn’t fit the true definition of a bear market, there was enough carnage below the surface to qualify in our work,” he said.

Now the 10-month has flipped back above the 20-month and we are firmly rising.

His view is that the slope of any given moving average is more important than prices above or below it. With a rising 10- and 20-month that are aligned properly, that gives us the primary definition of an uptrend.

Momentum: There are two different types of momentum, Krinsky stated: Market external momentum, measured by indices, and internal momentum, or that of individual stocks.

“Internal momentum isn’t that great,” he said. “If there were strong internal momentum, that would mean there are strong trends.”

This would mean there are stocks that are trending and outperforming, and that breakouts are working. That’s been a struggle last year and so far this year, he noted.

At the index level, one of the things he looks at is the monthly MACD indicator. Similar to the 10-month/20-month indicator, it takes a long time for this indicator to change and doesn't contain a lot of noise.

In September 2016, we had a MACD buy signal, Krinsky noted, the first in about 4 years.

“We’ve already seen some pretty good returns since then, but as long as that remains on a buy signal, I think that should be the focus there from a momentum perspective,” he said.

Breadth: One of the most important things here is to look at the number of stocks trading above their 200-day moving average, Krinsky noted.

Right now, the S&P is firmly above its 200-day moving average, but we want to look at other indices as well. The Russell 3000 has a broad base, consisting of about 98 percent of investible U.S. equities, and it shows that 73 percent of all stocks are above their 200-day moving average.

“That’s pretty healthy,” Krinsky said. “As long as we’re above that 65 percent threshold, that’s indicating you’re in a pretty good spot as far as breadth is concerned.”

Sentiment: This indicator is the only one out of the four that is signaling caution. Sentiment has become much more optimistic. For example, surveys from Investors Intelligence recently show bulls around the 60 percent threshold, which is what Investors Intelligence describes as the danger zone. The American Association of Individual Investors is also at an elevated level, Krinsky added.

“If we go back to Brexit and into the election, we’ve seen some massive swings from the fear that was prevalent ahead of those events, and then now we’re really on the other side of that,” he noted.

Sentiment is difficult to use as a timing tool, and in particular for trying to call market tops, because it often remains very optimistic for extended periods of time before meaningful drawdowns, Krinsky stated.

“It tends to be more timely at market bottoms,” he said. “The best way to think about it is, bullish sentiment is only a bad thing when the market internals begin to deteriorate and sentiment remains optimistic.”

If the first three checks begin to roll over, and we still see sentiment remaining very elevated, that would be a much bigger concern, he added. Right now, sentiment is no longer serving as a tailwind, but it’s hard to use it as a sell signal.

Listen to this full interview with Jonathan Krinsky, CMT by clicking here. Become a subscriber and gain full access to our premium podcast interviews with leading guest experts by clicking here.

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