, Investing Strategies

Extreme Tension

May 13, 2016 / by TradeSmith Research Team

As I reviewed markets this week using my own indicators two words came to mind – extreme tension.

Everywhere I look I see markets at crossroads and hitting extreme levels of sentiment and price. The US stock market is a poster-child of a market that could break big … in either direction.

Of course, the S&P 500 did recently trigger a new SSI Entry signal after rallying nearly 15%. The current VQ on the S&P 500 is only 11% so a bounce of 15% is well above the 11% VQ threshold. Moreover, the price action in the S&P 500 has been robust enough to turn our SSI trend indicator decisively positive. Those are the two conditions required to trigger a new SSI Entry signal.

As I wrote a few weeks ago, the rally that the S&P has staged the past couple of months is nothing to be sneezed at. The SSI Entry signal is a very conservative indicator. It does not get tripped lightly. The strength of this move cannot be ignored.

But I continue to believe that further gains in this market are going to be hard to come by in the near future. There are several headwinds that continue to concern me.

One of the biggest concerns, similar to my big concern for gold, is that the commercial players in the S&P futures markets are selling into this rally with glee. In fact, commercial future traders have the biggest net short position in the stock market we’ve seen in years.

The chart below shows what has happened to the price of the S&P 500 when commercial traders have been a bit less bearish than they are today.

In addition to my concern about market sentiment, my favorite short-term time cycle on the S&P 500 continues to do a good job of tracking price … and suggests further near-term downside to come.

Finally, a chart that I’ve shown many times before continues to concern me. This is the volume-at-price chart of the S&P 500 which shows at which price levels the shares have changed hand. Massive numbers of shares have changed hands around the current level. Many people are psychologically tied to these price levels because they have bought and/or sold here. It’s going to take a lot of energy to break above 2100 on the S&P 500.

So … the market has had a very strong bounce, the trend is up and the SSI Entry has triggered. On the other hand, the smart money is short, the cycle winds are blowing in the wrong direction and overhead volume is extremely heavy.

What’s a poor investor to do?
Last week I had the great fortune to be on a webinar with both Porter Stansberry and Steve Sjuggerud. As many of you know Porter is extremely bearish about the stock market (based on his macro observations) while Steve thinks that this market has a lot more upside to come (based primarily on market sentiment). It was great to have both Porter and Steve in the room debating the question of whether or not to sell in May and go away.

And it was great to be able to offer a third point of view.

One point that I always return to again and again is that we are all individual investors. While we happily pay our trusted editors and analysts to point us in the right direction, we are ultimately the last word in the decision making process. We do have to put our own stake in the ground in terms of our broad beliefs about where the market is headed and what investment opportunities we want to focus on.

But while we do need to decide which way we lean in our beliefs, we can prepare for more than one outcome.

My suggestion to listeners trying to decide between Porter’s bearish view and Steve’s bullish view was simple …

Figure out which way you lean and make sure that you’re set up to make a little extra if you’re right and not lose too much if you’re wrong.

It’s so easy to get caught up in extreme emotional opinions about market direction. Moreover, our current media culture is all about extreme views.

In the battle for clicks and eyeballs, extremism always commands a premium.

As investors, however, it can be very dangerous to be extreme. As investors, we need to be balanced.

As your investing experience, conviction and capital grow, you can afford to lean a little bit more heavily in one direction or another. You know more about managing risk. Novice investors (those with less than 10 years’ experience) can’t afford extreme positions.

It’s a good time to make sure that your portfolio is buttoned up and waterproofed in case the storm waters rise. But you don’t have to keep all your money under your mattress in order to protect yourself from an uncertain future.

In that spirit, I’ll wrap up today by offering the bulls an interesting long stock and the bears an interesting short-sale idea.

For the bulls, Orbital ATK (NYSE: OA) is an interesting looking opportunity. It triggered an SSI Entry signal back in early 2015 and has risen about 30% since then. It recently dipped into the Low Risk Zone with strong support from its SSI Trend and rose back out nicely. I believe it will soon go on to make new highs.

For the bears, on the other hand, IWO, the ETF covering growth stocks in the Russell 2000, looks very shaky. After hitting its SSI Stop Loss back in mid-2015, it made new lows, rose to kiss its declining SSI Trend and has started to head south again.