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Is the Market Getting Frothy? at Trader’s Narrative

It is notoriously difficult to pinpoint tops because unlike bottoms, they tend to form over a longer period of time. Still, there are several factors which are making me cautious here - just as I was bullish in mid-March.

Pedal to the Metal
Last week marked a historic occasion for the market. Albeit one that went unnoticed: the Dow closed positive in 19 out of 21 trading days. This was only the third time this has happened! The other two times? I’m not sure you want to know…

The first time was in August 1927 when the Dow corrected 10% (only a pause in its rocket ride to the 1929 top). The second was in July 1929 just before the last surge of the great bull market of the 1920’s. I don’t think this means necessarily that we’re going to crash. Just something to tuck into your hat.

The usual sentiment measures aren’t actually showing a lot of froth. Investor’s Intelligence is showing a tad too much bullishness from newsletter writers. But other sentiment measures are lukewarm at best. Put/Call ratios are, as well, in the middle ranges.

Annual Stock Market Cycle
There’s a saying on Wall Street: “Sell in May and go away!” for good reason. We have just entered one of the weakest portions of the 12 month stock market cycle. Many studies have shown a persistent bias towards the later months in the year (Sept - March) for relative outperformance. Obviously this is a pattern that emerges over many, many years and no one specific year has to follow it. Also, there are some rumblings that the pattern may be pushed out to late May or even June. According to Hirsch, from 1985 to 1997 May has been a stronger month than before. But summer doldrums are still summer doldrums.

Technical Signposts
Mark Hulbert mentioned today that Investors Intelligence is raising a red flag citing their “buying climaxes” proprietary measure. A buying climax is defined by II to have taken place when when a stock makes a 52 week high and then closes the week down. This is seen as a sign of distribution and as such, marks tops.

Last week there were 206 buying climaxes. But readings as high as 500 or 600 are not unheard of.

If you’ve been intelligent (aka lucky) enough to participate in this short burst rally, consider paring your longs and taking a defensive posture to allow the market the respite it needs.

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