Wednesday, November 4, 2009

November Stock market update

A couple weeks ago I made a case that U.S. equities were overbought and overvalued. We've had a little correction since then, and I've been asked if I think this is the beginning of a sell-off or a opportunity to buy the dip. My answer in a nutshell is: neither.

Stocks (on average, notably if you look at the S&P500) are still overvalued. This, especially in the context of less than goldilocky economic backdrop (see here and here), means that buying at these prices is speculation more than investment.

Furthermore, veteran technical analyst Richard Russell makes a strong case for a deterioration in market technicals (not online):
(1) Far too many distribution days.

(A distribution day is a day when stocks close lower on rising volume.)
(2) The bullish percentage of stocks on the NYSE is declining.
(5) The Transport Average broke below a preceding decline low October 28.
(6) Sentiment is too bullish regarding the market. Nobody expects this rally to top out and fall apart. Analysts consider it impossible that the March lows will be revisited again. I don't share their opinion.

Well this might not be entirely true: Mark Hulbert's sentiment index isn't showing worrying stubborn bullishness.
(7) My PTI is now only 8 points above its [moving average] and therefore very close to a sell signal.

The PTI is Russell's proprietary stock market indicator.
(8) The Dow, so far, has not been able to close above the 50% level of the 2007-to-2009 decline. The 50% level was 10725.
[10] Whether Lowry's Buying Power and Selling Pressure are spreading apart or coming closer together. Example, if on a given day, Buying Power drops and Selling Pressure rises, the spread between the two widens. That's technical deterioration. Since Oct. 19, the spread between BP and SP has widened by 45 points.
On the other hand, although market internals and breadth have turned a bit weaker in the past couple weeks, they haven't completely broken down in the way I would expect them to if we were on the verge of a nasty sell-off. Plus, in recent days they seem to have stabilized.

In conclusion, my best bet for the short term is that equity indices are going to settle in a trading range and test their recent highs. Whether the highs are bettered remains to be seen, and I am worried that an important top might be in the process of developping. The answer to that story could take weeks or even months to unfold.

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