Wow. What a rally.

When I said six weeks ago that I suspected that the stock market would likely rally faster and further than the neo-bears ever imagined, even I didn’t expect the S&P 500 to rally over 15% in six weeks and be on the verge of making new all-time highs.

The S&P 500 has rallied so sharply and strongly that it triggered a TradeStops SSI Entry signal this week.

Our SSI Entry signal gets triggered when an asset rises more than its normal expected volatility range (more than VQ%) AND our proprietary SSI Trend indicator makes a solid turn up.

Both of those pieces fell into place this week and the S&P 500 triggered a new SSI Entry signal.

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The move in the S&P 500 has been impressive … even unprecedented. I’ve been leaning bearish. I was just expecting a strong countertrend rally to be followed by more downside. The strength of this rally, however, has put me back on my heels with respect to my bearish beliefs.

I’m nervous about this new entry signal. I don’t want to believe it. Which is all the more reason that it may well be time to get long again.

It’s not that I don’t believe all of the data about how shaky things are in the global economy. I am convinced beyond a shadow of a doubt that our debt-fueled economy is unsustainable and that there is a steep price to be paid for all of the economic sleight of hand that has been perpetrated for decades now.

But I’m not fool enough to believe that I know exactly when the piper will come calling.

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For example, this week one of the smartest analysts I know pointed out that nearly 85% of the stocks on the New York Stock Exchange (NYSE) are trading above their 50 day moving averages. That’s a scary sounding statistic that strongly suggests that the current rally has come too far too fast. When I first heard it, my initial emotional response was something to the effect of, “Wow … maybe it’s time to go short the stock market.”

Is it?

The bottom area of the chart below shows the percentage of stocks on the NYSE that are trading above their 50 day moving averages. The top area of the chart shows what happens in the S&P 500 when such extremes are reached.

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The last time over 80% of the stocks on the NYSE traded above their 50 day SMA after such a sharp and sudden rise was nearly 5 years ago, in late 2011 (see the red ovals at the left of the above chart). What happened to the S&P 500? While we did get a short and sharp correction, the S&P 500 has since rallied over 60%!

So much for scary statistics.

Again, I’m not trying to be dismissive of the bearish case. There are lots of compelling reasons why the stock market is not likely to see big gains this year and why a sharp correction is long overdue. Just remember, many great macro-forecasters have gone bust before they were ultimately proven to be right.

The strength of this current rally cannot be ignored. It’s well beyond a garden variety counter-trend rally at this point. Our SSI Entry indicator is conservative by design. It takes a lot to trigger it. The strength of this rally has triggered our SSI Entry indicator … and strength often begets strength in financial markets.

Am I a full on bull now? No. I see serious headwinds dead ahead.

The NYSE stocks indicator that I shared above suggests a short-term correction may well be in the cards. In addition, the volume-at-price chart that I’ve regularly shared in these pages shows that the S&P 500 has run right up into the strongest overhead resistance possible.

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Other caution signs I’m keeping an eye on include the fact that the transportation stocks have not yet confirmed the bullish signal in the S&P 500. (If the economy is expanding you generally expect to see that busy-ness show up in the businesses that move stuff around.)

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And neither has the NASDAQ Composite.

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My proprietary time-cycle analysis also suggests a near-term correction.

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Again, there are definite caution signs regarding further gains in the stock market but the strength of this rally in the S&P 500 cannot be ignored. Personally, I’m now looking for a pullback in the S&P 500. The top of the Low Risk Zone on the S&P 500 sits at about 1,936.

If we get a correction to the top of the Low Risk Zone and the media are going crazy about how the sky is falling again, then I’ll most likely be an aggressive buyer of the stock market.

Sincerely,

Richard_Signature
Richard M. Smith, PhD
CEO, TradeSmith
Founder, TradeStops