Saturday, March 8, 2014

An overheated (but still bullish) stock market

Our Composite Gauge is reflecting an overheated market.  This indicator combines price oscillators with put/call and insider transaction ratios which measure what insiders and professionals are doing with their money. 

Recent readings of this indicator point to increased risk for the market in the short term.  The important 10-week moving average for the Composite Gauge hasn’t yet entered bearish territory but it’s headed in that direction, as you can see in the following graph.  Historically, when the 10-week moving average sends a reading of 45 or above it’s time to exercise caution and pull in the horns.

Note also that the Rydex Ratio has reached an historically “overbought” reading. This ratio tells us that retail mutual fund investors have become inordinately bullish in recent weeks and are likely setting the stage for a near-term top.

There are, however, reasons for expecting the indices to push higher before the next correction begins.  The Dow Industrials haven’t yet caught up to the S&P and should be able to do so, based on internal momentum factors.  With the Dow Transportation Average (DJTA) recently taking a leadership role, the Industrials are expected to follow the lead of the Transports.

[Excerpted from the Mar. 5 issue of Momentum Strategies Report]