Exit Signs

I.C. Angles Investment Post…

Investors are pouring money into the stock market. As the market makes new highs, they’re on track to allocate the most money into stocks since 2000, right before that market rolled into a bear market. The so-called dumb money is often late to the party, as most investors buy at highs and sell at lows. Dumb money rushing into stocks is just one more bearish sign in this almost five-year old stock market. But as many short sellers have found, as this market keeps making new highs, famous economist John Maynard Keynes was right when he proclaimed the market can stay irrational longer than you can stay solvent. Bears actively betting against this market are getting killed. No matter how negative the fundamentals, betting against a trend  is a good way to go broke. So, now might be a good time to consider what signs will indicate the current bullish trend has reversed, and the time has arrived to head for the exits.

Since June of this year I’ve made no secret of my concerns about this market, stating on more than one occasion I’m as bearish as I can be without technical confirmation of this bullish trend reversing. Unfortunately, the recent assurances of the likely future head of the Federal Reserve, who testified before the Senate that stocks are reasonably valued and there are no signs of a bubble, did not alleviate my concerns. Instead, given the Fed’s track record of consistently creating asset bubbles it has failed to predict, now seems a good time to go over some of those technical indicators that would lead me to becoming bearish and urge investors adopt defensive strategies. Already having advised profit taking and moving money without a long-term time horizon out of stocks, it is presently only the absence of such technical confirmation and the fact this market could stay irrational even longer that keeps me from embracing outright bearishness.

The first of three charts below shows one of the first meaningful technical levels a bear market will need to violate. The stock market, as measured by the S&P 500, continues to make higher highs and higher lows, and in doing so has remained about its 125-day Simple Moving Average. Trading below its 125-day SMA will be one of the earliest meaningful price-based, broad-market technical indicators of the current rally coming to an end. Other patterns to keep an eye out for would be a double-top or head-and-shoulders top, which see stocks begin to set lower highs and lower lows, as the market trades below its 125-day SMA.

SPX_2013_125

The next chart shows the entirety of the current bull market. A significant technical level is the 200-day SMA of which the stock market has not consistently traded below since 2011. In addition to the 200-day SMA investor can also key in on a simple trend line drawn from the market’s closing low point in 2009 through the closing lows in 2011 and into present day. A bear market will see stocks decline below its 200-day SMA. Of course the market doesn’t move in a straight line, and rallies can be expected. However, investors would do well to not treat such rallies as bargain buying opportunities.

SPX_2013_200

The last below chart shows an indicator I pay attention to, although I’m not aware of many others who do. The 500-day Exponential Moving Average (EMA) can be useful when evaluating long-term trends. The below 10-year chart shows the S&P 500 versus its 500-day EMA. And the last time the 500-day EMA slopped negative it was confirmation of a bear market.

SPX_2013_500

A good market timing rule is to not call a bear market until there are strong signs of a top already having been put in with some form of technical confirmation of a down move. Based on that rule no matter how negatively I view the stock market, I will wait until such an event before calling a bear market. But given my present outlook I am very much keeping an eye out for a top with technical confirmation of a  meaningful downtrend in progress from more than one such indicator. And I will make a bearish call based on multiple types of indicators, including fundamental, contrarian, historical and technical factors. The above charts show technical indicators I believe meaningful, but by no means would I advocate putting an investment portfolio on autopilot based solely on these levels. With that said at this point in time it is only technical indicators  such as these, which remain bullish, keeping me from becoming an outright bear on this stock market. Rather than rushing into this market, like so many others, now is instead the time to be making preparations for an exit.

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