Bull market? Then sentiment may not be too bullish

Good morning! It’s your weekly dose of TSP Talk. This market commentary is updated daily on www.tsptalk.com.

Stocks dropped sharply on Friday after a weaker than expected Consumer Confidence report, but there was some late buying. The TSP stock funds lost between 0.5% and 1.5% on the day, while bonds were up slightly.

The Michigan Consumer Confidence came in at 63.2, well below the 69.0 that was expected. They actually call it Consumer Sentiment, but I don’t want to confuse Consumer Sentiment with Investor Sentiment, which is quite different. We’ll talk about the latter in a bit.

Despite the selling, the S&P 500 continues to cling to the overhead resistance lines. While the summer strength has taken the market into overbought territory, the relatively flat action over the past two weeks has taken it out of any extreme reading. I won’t post the chart but the NYSE is just slightly overbought now.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

Taking a longer-term look, the resistance is even stronger than the chart above shows. The neckline of the 2008 head & shoulders (H&S) pattern, which broke down back in late 2008, could now also act as resistance, adding it to the November ’08 high, and the upper end of the current rising wedge formation.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

We have that 2008 bearish H&S pattern, which is coming back into the picture, and at the same time we have a large inverse H&S, which is bullish, that was broken to the upside, but its neckline has not yet been tested. Normally an H&S (or inverse H&S) pattern will pull back to the neckline before continuing the in the direction of the breakout.

Because of the resistance and because of the tendency for these H&S patterns to test the neckline, I can see a move down to at least the 940-950 in our near future. That is despite the fact the 50-day EMA is now above the 200-day, which by definition puts us in a longer-term bull market. A move back to the neckline would give us a very nice buying opportunity, as long as the S&P 500 stays above the 200-day EMA, and / or the 50-day EMA stays above the 200-day EMA.

The latest AAII Investor Sentiment Survey came in at 49% bulls, 21% bears for a bulls to bears ratio of 2.32 to 1. This is the most bullish “the herd” has been since late 2007.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

As I mentioned on Friday, our TSP Talk Sentiment Survey System is switching to bull market rules now that the 50-day EMA is above the 200-day EMA on the S&P 500 chart. The system officially remains on a sell signal, but as long as the 50 is above the 200, the bulls to bears ratio buy signal is anything under 1.25 to 1, instead of the bear market rule of 0.50 to 1.

The longer-term AAII chart below gives us a good visual of why the system’s bull/bear ratios are changed based on whether we are in a bull market or a bear market.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

There are buy and sell signals in both types of markets, but during a bull market the ratios are much higher than during a bear market. We are now seeing the highest ratio reading since the end of 2007 but back then we were in the bull market where the ratios would have been higher.

Our system, which did not fare well during the bear market, is based on our TSP Talk survey ratios, not the AAII survey. Our current survey results were 51% bulls / 35% bears, for a 1.46 to 1 bulls to bears. That is a sell signal during a bear market, but a neutral reading during a bull market. That 1.46 to 1 is a lot less bullish than the 2.32 to 1 AAII survey ratio.

Re-reading my comments, this may not have come across very clearly. Basically we are saying that sentiment may be too bullish for the market to continue higher, but if we are now in a bull market, then the ratios may not be overly extreme compared to if we were still in a bear market.

That’s all for today. Thanks for reading.

Tom Crowley
TSP Talk.

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