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Sunday, October 24, 2010

Weekly Market Update - cracks in the foundation?

It's been over a month since I posted a weekly market update. During that time markets have been moving steadily higher. As of this weekend, however, I am seeing a bit of a turn in our market statistics.

The view from Alert HQ --

The data for the following charts is generated from our weekly Alert HQ process. We scan roughly 6200 stocks and ETFs each weekend and gather the statistics presented below.

In this first chart below we count the number of stocks above various moving averages and count the number of moving average crossovers, as well. We then plot the results against a chart of the SPDR S&P 500 ETF (SPY).

This chart shows that roughly 5 out of 6 stocks closed above their 50-day moving average two weeks ago but that number decreased over the course of this last week. In addition, there has been a negative cross-over where the number of stocks above their 50-DMA has declined below the number of stocks whose 20-DMA is above their 50-DMA. This always happens when things get a little shaky or when stocks get a bit too extended. Looking at how the market proceeded in other instances, we can see that it is unlikely stocks will immediately plunge. Indeed, it is quite possible that the S&P 500 will continue to make new highs for a time while our statistics as presented above continue to show a weakening in breadth. This, to me, implies the market has reached an uncomfortable level of risk.

The next chart provides our trending analysis. It looks at the number of stocks in strong up-trends or down-trends based on Aroon analysis.

In this chart also we see the beginnings of deterioration. The number of stocks in strong up-trends has begun to decline and the number of stocks in strong down-trends is starting to increase. Both measures are beginning their reversals from what can be considered peak levels. This situation also implies a weakening in market breadth.

Conclusion --

A weakening of breadth as described above does not necessarily mean you should rush out and sell all your stocks. The two most likely outcomes are as follows:
  • Within a few weeks time we see a modest pull back. I think earnings have been good enough that any move to the downside will be limited. This might actually provide some nice entry points.
  • We are at the beginning of a consolidation phase where stocks stop trending so strongly and move sideways for a while. This is not a terribly bad thing either as it sets us up for further gains (hopefully) after the market has digested the current run-up.
So the main take away here is that you should feel no pressure to buy stocks right now in fear of being left behind by the market.  This is a good time to populate your watch list of investment candidates. Like I always do, I'll recommend that you keep an eye on Alert HQ and the new Alert HQ Premium for good ideas.

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