S&P 500 Getting Stretched - Topping Process Likely Underway

Thu, Mar 31, 2016 - 10:00am

2016 started out with a bang. As people flipped their calendars forward to a new year they were immediately greeted by a double-digit correction in the stock market. Fears of a global recession and a blowup in the junk bond market swept over investors as the price of oil continued to crash to new lows.

In lockstep fashion, the S&P 500 and the price of West Texas Intermediate (WTI) crude bottomed in mid-February (the final bottom in crude was /barrel) and the stock market has ripped higher by 13% since. Having now erased all its earlier losses, the S&P 500 is showing a 1% gain year-to-date.

After correctly predicting the turmoil that would result from events surrounding China and its currency in August, the widely-esteemed market strategist Felix Zulauf told Financial Sense listeners again in December that 2016 would likely see some very dramatic moves—both in stocks (down) and in the gold market (up)—with opportunities abounding for nimble traders but making for a hellish environment for long-term buy and hold investors. Needless to say, his outlook turned out correct.

Looking at the chart above, there is now good reason to believe the rip-roaring 13% rally from mid-February has come too far too fast and may be in the process of topping out.

Periodically the S&P 500 will get extremely stretched, moving too far above or too far below its 50-day moving average indicated by the horizontal red and green lines. When this happens, we typically see an important top or bottom in the market take place.

The S&P 500 is currently trading 6% above its 50-day moving average and may chop around at these levels or even push higher. That being said, it is nearing a point of exhaustion with many sentiment measures now in overbought territory, some even registering frothy levels of "extreme greed" on the part of investors. Upside gains may be limited with a topping process the most likely course of action.

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