The Short-term Outlook for the Stock Market is Turning Cautious

Of course, there are so many moving parts that the stock market measures, it is almost futile to try to figure it out, but that is where our indicators come in.  Our Psychology Composite moved to P4 recently, and several of our indicators are hitting extremes that often signal at least short-term caution.
For instance, we evaluate the volume of the more speculative NASDAQ exchange to that of the more conservative NYSE exchange.  The theory is that when speculative volume (usually a characteristic of dumb trading) moves up to the red zone, it is a danger sign.  You can see the results below.  In every instance, at least a short-term correction was in the cards.
This is happening at the same time that:
  • one of our best Psychology indicators - the Rydex Ratio - has moved up close to 47%, which is one of the highest bullish readings that, other than during the corrections of the recent years, hasn't been seen since that 1998-2000 period. (Read more about this indicator here in last week's post.)
  • the stocks in the S&P 100 have been strongly outperforming the S&P 500 since around March of this year (and really since that trough of relative strength in May 2011).
  • the Value Line Arithmetic Index, an arithmetically averaged equally-weighted index, is showing a mirror image pattern in relative strength against the S&P 500 as the S&P 100, in a downward trend.
  • the Dow Jones Transportation Index is also seeing a downward trend in relative strength against the S&P 500 since about February of this year, similar to the Value Line Aritmetic Index.  Not only has the relative strength been dramatically under-performing, but the recent action in the Dow Industrials has not been confirmed by the Dow Transports.
The bottom line of this story is that one of our main pillars of analysis, Psychology, is definitely showing a weaker picture.  It is not to the P5 rating yet, but some of its most important indicators are flashing a yellow light.
However, we have two other pillars - Monetary and Valuation - telling us that the long-term bull market is still alive and well.  So our reading between the lines is to hold off on any new buying, exercise a little caution, but don't throw the baby out with the bath water.  Bull markets don't end until Monetary turns negative, and as of this time, it is still very powerful in its support of the bullish case.
Don Hays
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