Is stock market setting up a top?
Yes, the market is overbought, overvalued and overbullish. But that in itself does not tell us much about the most likely near-term trend. One way of gauging the outlook is to analyze so-called market breadth.
“Where breadth goes, the market usually follows,” goes an old market saw. Analyzing one measure of market internals, the number of S&P 500 stocks trading above their respective 50-day moving averages has increased to 90% from 18% in early February (see chart below). This Index rose until the beginning of January, then stalled, before selling off. It is now again stalling at a high level.
“At these levels, there really hasn’t been much more room to run on the upside before a short-term pullback (or at least sideways trading) has been seen,” said Bespoke. Of the two momentum-type oscillators (ROC and MACD) at the bottom of the chart, the MACD has just broken the zero line, thereby reversing course from buy to sell mode, and the ROC is very close to doing so.
For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 90% – somewhat down from its October peak of 96%, but nevertheless firmly in bullish terrain.
Although the longer-term uptrend remains intact, stocks could be forming a short-term top of sorts and my advice is that investors should lighten up, in particular during performance gaming for the end of the first quarter. Rather be defensive as the Fed exits from bailout-related credit facilities and quantitative easing (i.e. monetization of mortgage-backed securities and agency debt). Timing of a primary top is largely guesswork at this stage, but the usual causes are not. “Bull markets are usually assassinated by tighter monetary policy,” added David Fuller (Fullermoney).
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