Trader’s Narrative

We’ve recovered around 10% from the darkest days of the market slide in January. Tragically for the bears, the world didn’t end. At least not yet.

While it all looked gloomy and depressing, it is important to remember that this is the stuff that stock market bottoms are made of: panic and fear, predominant bearish sentiment and major technical indicators hitting extremes… all accompanied by bad news.

But the market doesn’t go up (or down) in a straight line. Now we are overbought in the short term. The percentage of S&P 500 components trading above their short term 10 day moving average is slightly above 90%.

Just as an extreme low reading indicates a great buying opportunity, a high reading is an indication of caution. For more information read Lowry’s research.

Here’s a recent chart with the red line indicating the +1 standard deviation and the red line the -1 standard deviation:

Having said that, this matters in the short term. We could easily work off this level of overbought by treading sideways for a week or so. Or we could move down slightly.

A high reading from this indicator doesn’t mean it is automatically time to sell or sell short. Especially if you have a long term time horizon.

A good example of that is what happened in mid September 2007 when the percentage of S&P 500 stocks trading above their 10 day moving average peeked above 90%. The S&P 500 itself meandered for a few days and then went higher (and reached its swing top in October 2007).

The good news is that while this short term breadth indicator is overbought, the percentage of stocks above their 50 day moving average is only 40% and those above their long term 200 day moving average only 25%.

The really scary thing would be if any of these were 75% or higher. But we are still too close to the precipice ( the fall apparently avoided) for that.

The Investor’s Intelligence Long Term Composite Indicator is a proprietary indicator generated from the scores awarded to over forty indicators. These indicators have been selected across a wide range of disciplines covering index trends, breadth, sentiment, money-flow and financial/economic factors. The scores awarded to each indicator are weighted to create an indicator that generates signals at market extremes…

The last time this aggregated indicator reached similar extremes were in August 2007, summer of 2002, and October 1999. So although the II sentiment measure is stubbornly stuck in bullish mode, their Composite indicator is most definitely flashing a buy signal.

My guess is that it is because of the rapidity of the decline as well as the low bullish percent indices for so many sectors.