Market Sentiment Still Showing Positive, No End In Sight

Over the past week all of our core market health indicators improved, however, none of them improved enough to change our core portfolio allocations.

Market Positives
We continue to see price move higher in the S&P 500 Index (SPX) while perceptions of risk go lower. Our measures of risk are signalling that investors and traders have little long term concern. Our measures of the economy, market quality, trend, and strength all improved late this week, while measures of market breadth are at historical levels. This signals that even reluctant buyers are entering the market. Our investor contentment index shot substantially higher over the past two weeks which is another sign of money flowing into stocks.

Our Twitter sentiment indicator for the S&P 500 Index (SPX) is painting moderately high readings on up days and fairly flat reading on down days. This is a positive sign for a market making new highs. Even though there continues to be a very large number of tweets concerned with overbought conditions there are enough tweets showing excitement about higher prices that the daily indicator doesn’t travel far below zero.


The concern about overbought conditions is showing up in smoothed sentiment where it is painting a negative divergence with price. As prices move higher more traders are showing skepticism. This indicates that the probability of a pull back in the near term is rising. Unfortunately we don’t have the conditions in place to issue a consolidation warning if price pulls back immediately.

There are two things necessary for a consolidation warning. First we need a solid uptrend line in smoothed sentiment that confirms the move in price. At this point we feel it’s too early to use the last low as a reference point. Our second condition is a divergence from price that lasts at least three weeks and preferably a month that subsequently breaks our uptrend line. The current divergence has only been in place a few weeks. The reason we prefer a longer divergence is that people change their minds slowly. It often takes several days and even weeks for the weight of evidence to build to a point where market participants change their mind. In the current environment we see more traders every day get concerned about overbought conditions. This is showing up in moderately high daily sentiment readings on very strong price moves (and the negative divergence in smoothed sentiment mentioned earlier). At this point we have warning that traders are getting concerned, but no warning of a possible decline.

Support and resistance levels generated from the Twitter stream pointed at 1700 on SPX and almost nothing else. There were a lot of tweets mentioning the current price during each day, but not a lot of predictions. The market closed barely above previous resistance of 1665 on Friday. We like to see a market close above a resistance level for a few days before we call it support so 1665 on SPX remains resistance. Below the market 1650 is a small support level, but 1600 is where we find major support.

Sentiment for the various market sectors improved almost across the board. It appears that everything is being bought. Even with strong support for financials, technology, and energy the defensive stocks had a positive bias. One thing of note is that sentiment for consumer discretionary stocks and basic materials fell.

From a sentiment perspective the market is in a frenzy. Overbought conditions can’t bring daily sentiment far below zero. Traders are targeting 1700 on SPX and nothing else. Meanwhile, every sector is showing positive sentiment readings. Right now we can’t tell when it will end so we’re simply enjoying the gains.

Mixed Signals
Most of our core market health indicators are negative, but improving as we mentioned above. They are so close to turning positive that we suspect that they’ll be there by next week.

Market Negatives
Over bought conditions abound, but no one cares.

Conclusion
It appears as if there is no end in sight for this rally…so it’s probably over. Seriously though, it does appear as if everyone wants to increase exposure to stocks. We’re sensing a general mood that investors feel the Federal Reserve and the European Central Bank have everything under control. This is causing a shift in portfolios. Our personal opinion is that the current optimism is misplaced. We try not to be smarter than the market so we’ll continue to follow along with the belief that our market risk indicator will save the bulk of our portfolio if the market turns.