With the S&P 500 remaining close to 2,900 and its all-time highs, it may be very tempting for some to double down here on existing positions. We lightened up on some of our equity positions recently due to how long this intermediate cycle has been spanning. We are now almost 30 weeks into this present intermediate cycle which means equities are now well past their timing band for printing an intermediate cycle low. In fact, the longer the market keeps rallying, the more we believe that equities will experience some type of mini crash like we had back at the start of this year (February).
Before we get into our short-term outlook, equities clearly remain in a long-term uptrend. From our cycle analysis and sentiment readings, it is clear that we are nowhere near a multi-year cyclical top at present. The trend is one’s friend at present. Long positions can be protected by something like a monthly moving average stop loss or just by lightening up at intermediate and/or annual tops.
The S&P, for example, printed a clear 4-year cycle low back in early 2016. A 4-year cycle low takes place when stocks deliver a failed yearly cycle. A failed yearly cycle is when we get lower annual lows as shown on the chart below. This is perfectly normal. The key is that the longer cycles are trending upwards as this confirms the bull market. This is what we certainly still have in equities at this point.
Apart from long-term cycles, we also look at long-term sentiment readings and particularly the robo ratio. This ratio is a good read on how retail investors are trading equities in the options market. When the ratio is below the ultra-optimistic level of 0.5, it means that retail traders are buying far more calls (bullish) compared to puts (bearish). While we may be overly bullish at present, the ratio is still nowhere near the levels we witnessed between 2005 and 2007 just before stocks put it a major cyclical top. In fact, the readings we have at present are pretty consistent with an intermediate top which we are long overdue. We would need to have sustained bullish ultra numbers before a cyclical top could take place. We are just nowhere near those type of frothy levels at present.
Source: Sentimentrader.com
From a nearer term perspective though, this is not the time to be doubling down. Stocks have just printed a daily swing high. The next target is the 10-day moving average on the S&P which is around the 2,882 level. This level would also give us a weekly swing high. If we could breach this level, it would in all likelihood mean that not only would we be dropping into a daily cycle low but also an intermediate cycle low.
The S&P did drop to a lower low on the 15th of August (2,802), so it looks like we have a brand new daily cycle at play which is just 14 trading days old. Considering where we are in the intermediate cycle (29 weeks since last February), we are expecting this daily cycle to left translate (top early) and drop down into an intermediate low.
The shallowness of the intermediate trend-line (below) along with the overbought levels on the slow stochastics and RSI momentum indicators demonstrate to us that an attractive buying opportunity may be brewing in equities. As mentioned, the longer this intermediate cycle continues, the higher probability we have of a steep downturn occurring at the tail-end of the cycle.
So, from a short-term basis, we definitely have some risk in US equity markets at present. The NASDAQ, for example, is even stretched higher above its moving averages although it has also printed a daily swing high. Furthermore, with the Fed more than likely raising rates at month’s end, one feels that if a significant correction is going to happen, it must happen this month. Over the past few years, equity markets have had the uncanny ability of trading near all-time highs when the Fed moved on rates. We do not think this time around will be any different.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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