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Mark Hulbert recently wrote an article for MarketWatch.com about the independent newsletter sentiment survey his firm conducts to gauge investor sentiment.  He reports extremely high levels of bullish sentiment which, as a contrary indicator, is a warning about the stock market.

Marty Chenard is also watching sentiment, but by studying the VIX.  He reports that the VIX has approached a critical point, and that the direction it takes over the next few days will be important regarding the direction of the stock market.

All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.  WHAT THIS SITE IS ABOUT 

As mentioned last week, a look back at ten years of the yield curve indicates that the level of rates, as well as the slope and the duration of the curve, are not yet as restrictive as the last peak in late 2000.  At this point, the inverted curve does not appear to be negatively impacting the stock market.  In fact, the current level of long rates may be helping to support stock market prices, along with the prospect of lower short-term rates.  

However, an inverted yield curve is a very important signal for all markets, and particularly the equities markets.  The inversion traditionally signals a likely economic slowdown, and the first signs of the slowdown are already being reported.

US Treasury 2-year, 5-year, 10-year and 30-year rates have all dipped below, and have held under, their 39-week moving averages (MA).  This recent weakness in rates no doubt reflects recent weakness in economic growth.

The 10-year rate is particularly important to watch at this point because it is near an upward sloping support line that was touched and confirmed several times over the past four years.  A break below would be an added signal of lower rates ahead.

As mentioned in yesterdays’ report, the US Dollar failed at important long-term horizontal, trend line and moving average resistance.  Moving above this confluence of resistance would be an important signal, but for now the dollar weakness confirms the trend lower in rates and supports the view of Fed easing early next year.

All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.  WHAT THIS SITE IS ABOUT 

Over the past two weeks there has been a rotation into the former short-term lagging sectors of Utilities, Materials and Energy.  This rotation completes the participation of all the major sectors in the market rally that began mid-June, and confirms the rally’s underlying strength.  However, it also means that there are limited options for new low risk sector investments and that there is an increased need for caution.

The Technology and Discretionary sectors have performed very well since mid-June, and this may be indicating that there is more economic strength than the current GDP numbers are revealing.  This strong recent sector performance may also be reflecting the undervalued fundamentals of this area as it underperformed the general market over the past year and a half.

Recent strength in Materials, Energy and Utilities may also be pointing to under-rated current economic strength.  On the other hand, it may also be pointing to upcoming weakness in short-term rates and a weakening dollar.  Only time will tell regarding rates and the dollar, but it is better to see this sector rotation as a flag, warning investors to watch for developments in these other areas.

Regarding the direction of rates, here is a quotation on this topic published this morning by Barchart.com.  The bottom-line is that the market is now anticipating lower short-term rates.

"Expectations for Fed policy eased after last Friday’s weaker than expected Q3 GDP report of +1.6%. The market is no longer discounting a small 10% chance of a Fed tightening in the Dec-Jan period, as it was earlier last week. The market is now fully discounting an unchanged monetary policy through January 2007, and is then fully discounting a 25 bp rate cut to 5.00% by July and a 42% chance of a further cut to 4.75% by September. The next FOMC meeting isn’t until December 12, when the market is unanimously expecting no change in Fed policy."

Absolute Sector Strength since October-10-2006

Relative Sector Strength since June-15-2006

Absolute Sector Performance Rank since June-15-2006

***All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.***

This site utilizes technical analysis to determine the status of the current intermediate and long-term trends of the markets.  For more information about technical analysis, please refer to this book by Martin Pring, "Introduction to Technical Analysis".

The intermediate trend is very loosely defined as 3 to 9 months, and the long-term trend is loosely defined as 3-5 years.  The goal is to define favorable, low-risk intermediate and long-term periods to invest, and to define unfavorable, high-risk periods when investors should exercise caution about the market.  Times of caution call for restraint in opening new positions, taking partial-profits, raising cash, hedging current positions, etc.

There is no guarantee that during times of low risk the market will rise.  But investing during these periods provides a more favorable risk-reward outlook where the risk of losses is smaller and the potential reward is greater. 

It is this author's opinion that the majority of equity investments should be made in diversified products such as mutual funds, and that all investors should use "loss management techniques" as explained in Martin Pring's book mentioned above.  Loss management techniques include buying near important support levels so that if the support is broken, the position is sold and losses are limited. 

Investors should commit only a reasonable percentage of their total funds to the equity markets, while the remaining funds should be diversified among real estate, commodities, fixed income and cash equivalents.  The bulk of the funds should be retained as savings invested in safe vehicles such as money market funds, Treasury Bills and Certificates of Deposit.

Below is a figure from Martin Pring who describes three major trends of the market: the short-term (red dots), intermediate-term (thin blue line) and long-term (thick green line).    The short-term trend is too difficult and costly to trade, but the intermediate trend, and particularly the long-term trend, provides opportunities.  For more information about this figure, access www.pring.com.

Investing strategies should correspond with the long-term trend. In other words, purchases should be made during long-term up trends, but during the low points of the intermediate trend.  On the other hand, investments and purchases should be limited during downtrends in the long-term cycle. 

Technical analysis can be employed to determine the cycle low and cycle high positions of these trends.  In technical analysis, several approaches are taken to determine the current position of the market.  This includes sentiment surveys, market momentum, breadth, time cycles, overbought and oversold indicators and inter-market analysis of the four major investing markets: Bond, Stocks, Commodities and Currencies.

All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.

The Bullish Percents have solidly confirmed the current market rally, but the current high levels indicate that investors need to be cautious.  The high levels in these Bullish Percents indicate a very strong, broad-based market, but also a heightened level of risk of a short-term market correction.

All but two of the important indexes being tracked are above the bullish 50% line.  The laggards are Precious Metals and Semiconductors.  The lagging metals partly reflect the correction from the parabolic spring highs, and the uncertainty regarding short-term rates.  The Semiconductors is an influential sector and the fact that it is lagging is one of the few remaining important worry spots for the market. 

Canada moved to a column of X and above 50%, Precious Metals moved to a column of X, and Materials moved to above 70%, all reflecting new strength in natural resources.  The Industrials sector moved to 80% and Telecom is at 100%, both now are considered overbought.  Financials showed a little weakness ticking down slightly below its peak, but still in a column of X.  Financials are very influential and also a leading sector and is therefore an important sector to watch for clues about the future direction of the short-term trend of the market.

Regarding the moving averages (MA), there is also broad-based strength confirming the market rally.

The Water industry just moved above the 39-week MA after forming a two-month base, although it is still below an important high consolidation which could be difficult resistance. 

Biotech is in a strong uptrend after breaking out of two-month base as well, but it is now at 5-year new highs with less resistance to hold it back.

Broker/Dealers have made a strong move up to the former highs of the past spring.  This tends to be another leading and influential industry and should be watched to see if it can confirm by breaking out above.

Grains continue to surge after breaking a 2.5-year downtrend reflecting the Australian and US droughts, and also perhaps the very long-term trend towards a generally rising level of world-wide commodity prices.

The most notable event of the week was the US Dollar failure at resistance of both an important resistance level and the 39-week moving average.  Not much chart damage has occurred yet, and the dollar could turn around and surprise with a move higher, but this failure should be watched carefully because of its very important implications regarding short-term rates, economic strength, commodity prices, etc.

Speaking of commodities, the Morgan Stanley Commodity Shares index just broke above the 39-week MA after forming a 3-month consolidation that touched the lows and bounced impressively three times.  The index is now at short-term resistance.

(Items are noted in black in the figures below as important to monitor because they are near their 39-week MA, either just below or just above.)

***All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.***

In general, breadth and volume continue to remain positive and are confirming the current rally.  Just like last week, the New York Exchange (NYE) is generally more supportive than the Nasdaq, but both exchanges are showing solid indicators.  However, a number of indicators have reached, and are now exceeding, prior highs.  This indicates that it is time to be cautious about the equity markets.

One of the more reliable indicators is the Summation Index available for the NYE and Nasdaq.  It has now exceeded the highs of the spring for both exchanges and is therefore at an extended level. The Summation Indexex for both the New York and the Nasdaq also shows the spread between the summation indexes and their 200-day moving averages (indicated by the thick line), and both are now exceeding their prior highs.

The New Highs/New Lows indicators for the NYE and the Nasdaq show clear behind-the-scenes support for the current rally.  This will be one of the important indicators to watch for any advance signs of weakness in the market, and clearly that weakness has not yet occurred.

The Advance/Declines, Total Volume, Up/Down Volume and On Balance Volume for the NYE and the Nasdaq are all supportive and confirming the uptrend in prices.   MarketGauge.com is reporting decent accumulation over the last two weeks and only normal distribution, but the first sign of distribution is being reported by Investorsintelligence.com.

The Bullish Percents for the NYE and the Nasdaq have continued to tick higher for both indexes on both the up and down days of the market which continues to support the current rally.  The NYE Bullish Percent is just below the 70% overbought level, but the Nasdaq Bullish Percent is at a safer level of 55%.

Neither the US Dollar nor the Euro crossed their 39-week moving averages (MA) since last week.  The US Dollar is close below its average and the Euro is close above.  The US Dollar is important to watch because a break above for the US Dollar would help confirm that its recent price action is a consolidation in advance of a move higher.  It would also help confirm the recent positive trend in the relative strength of US equities vs. foreign equities, and therefore indicate investors might favor investment in domestic equities vs. foreign.  In addition, a break above for the US Dollar would help indicate that short-term interest rates will remain firm and that perhaps Fed easing is less likely.  Most importantly, a break above for the US Dollar would signal a limit, at least in the short-term, to the increases in prices of precious metals and commodities in general.

Industrial metals remain well above the MA and have broken slightly above short-term resistance with the all-time high as the next resistance.  In addition, the current chart strength is supported by the RSI which has remained in a very strong bull range, and the MACD which has corrected to a supportive level and may cross over soon (weekly MACD signals are often reliable).  Industrial metals (copper, aluminum) are important to watch.  They can indicate underlying industrial strength, and (or) they can be a leading indicator of commodity inflation, dollar weakness, and the direction of interest rates.

Agricultural prices have been surging recently breaking to new highs.  During the commodity boom of the past two years, agriculture was a weak spot.  Now it looks like it is joining the other areas of the market and confirming the uptrend.   Droughts in Australia and the western United States are contributing heavily to the increases, but the world wide trends of high demand from awakening emerging markets, low rates and underlying currency weakness are impacting agriculture the same as other commodities.

Commodity Related Equities prices have also been strong lately, including Energy related shares. (This depends on the commodity related equity index such as Morgan Stanley vs Goldman Sachs. They have different weightings, particularly for energy.)  The shares usually lead the commodity so the equity index works as a leading indicator for the direction of commodities (and the dollar). 

Gold is one of the only important commodities missing from the overall pattern, and will be important to watch.  Gold usually is the leader of the pack so it is odd that it is lagging while other commodities are leading, and therefore it will be important to watch whether it eventually confirms the trend.

***All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.***

The Short Interest Ratio represents the number of days it would take to cover short positions. It is calculated as the Short Interest for the Current Month divided by the Average Daily Volume if trading continued at the average daily volume for the month.  A low number represents extreme optimism which is bearish for stocks, and a high number represents extreme pessimism which is bullish for stocks. 

In May, there was an extremely low level of short interest (optimism) that coincided with the market sell off.  In fact, it was the lowest level of short interest since the bull market began in the fall of 2002, so isn't surprising that it was also one of the most severe market corrections.  In September, there was an extremely high level of short interest (pessimism) that coincided with the current market rally.  It was actually the highest level of short interest since early 1998, so it is consistent that the current rally has had so much strength.

In October, the ratio fell reflecting a decrease in pessimism, but the current level still shows a good deal of skepticism by investors which is surprising considering how strong and broad based the recent stock market rally has been.  This pessimism will help support the markets until the ratio works its way lower close to previous levels of optimism. 

Sentiment analysis is an important component when following the markets.  If too many people are bearish, there aren't enough sellers left, the balance tips to buyers and the market starts to advance.  If too many people are bullish, most funds are already invested, the balance tips to sellers and the market weakens. 

One way to determine if investors are bearish or bullish is by taking surveys and tracking at what levels these polls indicate investors are at the extremes of bearish or bullish sentiment. 

The chart below shows four polls and their current sentiment levels.  Keep in mind, sentiment analysis is not a science and only provides very general information.  Sentiment is not a signal to take action, but is a warning about the current state of the markets.  There have been many occasions when bullishness reached high levels well before the market started to weaken.

The current sentiment readings are mixed but show a shift to more neutral levels from the prior week.  The fact that the polls show a range where some still show skepticism while others are bullish points to a generally neutral level of overall sentiment.

The II survey ticked up slightly but is still below prior levels of bullishness registered when the markets were at prior cycle peaks.  The AAII survey moved up from a neutral level to a moderately high level of bullishness.

The Birinyi blogger poll is new so there is not much history to judge bearish and bullish levels, but it shifted back down to what appears to be a general level of skepticism which diverges from the II and AAII surveys.

Market Vane remains just above at a level of general optimism.  This poll has a different range than the others.  In the bull market that began early 2003, skepticisim is registered near or below the 55% level, and optimism is registered near or above the 70% level.

***All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.*** 

US Treasury 10-Year rates held at the level established last week when rates found support at the lower trend line and then bounced higher up to a level just below overhead resistance set by the 39-week moving average. The current range of 10-year rates appears to be in the sweat spot having a helpful impact on the equity markets.

30-Year bond prices have held right where they declined to last week at important support.  This occurred after failing at the old neckline of a pattern that looks like a head & shoulders top. 

The US Dollar still looks to be in a bottoming process and just below important resistance.  It pulled back this week to short-term support and bounced higher, although still in the lower half of the current channel uptrend.  The movement of the dollar will provide important clues regarding the direction of short-term rates and the next important moves by the Federal Reserve regarding Fed Funds rates.

***All charts and comments are intended for educational and discussion purposes only. No investment recommendations are being offered.***