The equity market appears to be in a stealth bull market for now. Everyday it somehow manages to shrug off the extreme bullish sentiment and notch up just a few points more, climbing higher on the chart.
If we look at the most recent major highs and lows, the current S&P 500 index level is within a resistance zone. This explains why it is moving so slow now and why it was pushed back earlier in April and again in November 2010.
While it isn’t visible on the chart below, the previous support line (now resistance) at 1225 also goes back to the bounce we saw in the summer of 2006 (June-July).
As well, this level corresponds to the Fibonacci 61.8% retracement from the top of October 2007 and March 2009 lows. The exact level is 1225 on the S&P 500 index.
Bullish Percent Index
I like to time the market in the intermediate to long term with bullish percent indexes. Traditionally, when an index is above 30% it is considered to be demonstrating bullish conditions. My approach is to watch for extreme spikes and very high levels as exhaustion points.
One exception to this is a momentum market that can deliver a sustained high level in the bullish percent index. We saw this in the 2003-2004 bull market and again more recently in the liftoff from the March lows when ‘overbought’ conditions in late 2009 to early 2010 meant very little.
The fact that the bullish percent index for the S&P 500 index wasn’t able to sustain itself above 70% and instead fell to a low of 40% in early July is a bit troubling. This increases the chance that this is a top instead of a momentum market characteristic.
The one silver lining is that in contrast to the October 2007 top, the current level shows a very high level of participation. At the October 2007 top, while the S&P 500 was battling resistance at 1550 for the second time since July 2007, the bullish percent index was lower then (70%) than in July 2007 (75%).
This wide participation in the bull market is something that I’ve touched on more than a few times in the past. Recently in early November: Cumulative Breadth & New Highs Skyrocket. My short term bullishness didn’t turn out that great as the market had a hiccup. But then it managed to climb above the November highs.
While we may stand aghast as the bull market tenaciously climbs higher, it is important to notice that it is doing so with rather firm footing. Various breadth measures such as the S&P 500 index’s own cumulative breadth index or the S&P 500 Equal Weight index, are both showing a robust degree of fortitude.
The S&P 500 Equal Weight index also shows the wide participation of as well as the outperformance of smaller capitalization issues:
The S&P 500 Equal Weight index has returned appx. 18% year to date, compared to 11% for the S&P 500’s capitalization weight index. The outperformance continues the more we consider smaller capitalization issues – but that is another post altogether.
Right now the equal weight index is bumping up against the resistance line at 1900. But otherwise, it seems to be in a fit and healthy bull market.
Percent Above Moving Averages
Turning to the percentage of stocks above their moving average, the medium term breadth measure of the S&P 500 index stocks trading above their 50 day moving average shows a healthy level of bullishness without yet being extreme:
This means that the market could move slightly higher before this breadth measure reaches extreme (90%). However, keep in mind that previous tops have occurred at this level (80%). For example, in January 2009 and October 2007.
Perhaps more importantly, especially for the longer term outlook, the percentage of S&P 500 index components trading above their 200 day moving average is once again climbing to ‘bull market’ momentum levels. At 86%, the current reading is indicating that the vast majority of stocks are trading above their long term trend.
Compare this to the reading of just 63% in October 2007 as the market was making another attempt at 1550. In July 2007 this indicator was at 72%. So even though the index levels were similar, the underlying strength in the market was deteriorating markedly. We are not seeing that now.
To sum up, it is true that we are in an unmistakable period of exuberance. We’ve looked at the sentiment indicators which are pointing us to that conclusion.
As a brief update on the sentiment front, I should point out that the (10 day moving average of the equity only) ISE sentiment index call put ratio reached a new record today at 267. And the 5 day moving average is at 268 (within a hair of its own record on December 6th, 2010). The CBOE equivalent is 212 calls for every 100 puts – not too far off the ISE numbers. There are clearly enormous amounts of call buying from retail traders.
So I wouldn’t be surprised at all to see a pullback in the short term. The market is certainly overextended but it seems that it really wants to overdo things this time. Because of that I don’t feel comfortable putting on new long positions here as I don’t think the risk to reward ratio warrants it.
Nevertheless for all the reasons detailed above, in the medium to intermediate term there is no strong indication that the bull market that started in March 2009 is done yet.