Warning Signs

February 7, 2013 (4:45 pm)

As we’ve discussed at length over the past couple of weeks, it looks like we’re reaching an intermediate-term top in the markets. There have been a number of warning signals that have been yelling “Caution – Decline Ahead!”.

  • Insider Selling: The Vickers Weekly Insider Report calculated the sell-to-buy ratio for NYSE-listed shares at 9.2-to-1. This means that insiders of these companies, on average, sold more than nine shares for every one that they bought. The last time it reached this level was in late July 2011, just before the debt-ceiling debacle drove a serious market correction.
  • Newsletter Sentiment: Newsletter writers are recommending a record level of exposure to the equity markets (currently 76% – a level last seen in the summer of 2000, just prior to the dot com bust).
  • Investment Manager Sentiment: Investment managers were polled by NAAIM on their level of exposure to the equity markets. It currently sits at 104%. That’s right… it’s over 100% allocation. That means that, on average, investment managers are buying equities on margin.
  • Seasonality: February is historically a weak month for the markets.
  • Bollinger Bands: The SPY and QQQ both leaped above their upper Bollinger Bands in early January. These bands measure two standard deviations from the 20 day moving average. This means that the acceleration in price was enormous, and is typically used as a signal that things moved too far, too fast.
  • Volatility: We’ve seen volatility collapse over the past few weeks. Recently, the $VIX (a measure of volatility) has found a bottom and has been inching up. In the past, when the $VIX bases and begins to rise while the market is still making new highs, it has indicated that a near-term correction is around the corner.
  • Reversals: We have seen a number of significant reversal days. When we witness these reversals of reversals after a sustained bullish or bearish trend, it indicates that the trend is coming to an end. The bulls and bears have become evenly matched here, and the bullish reign is likely over.
  • Breather: The SPY has climbed over 13% over the past ten weeks and is due for a breather.
  • Dow 14,000: When the market nears a major milestone, it’s rare that it doesn’t at least take a shot at that level. Over the past few weeks, Dow 14,000 has been the jackpot that many were looking at. They just wanted to touch it to see what it felt like. Now that we’ve reached that milestone and tried – and failed – to hold the line, the bears have a much strong chance of taking over.
  • QQQ Head and Shoulders: The QQQ head and shoulders pattern that we first mentioned a couple of weeks ago is very real. When you see such a clear cut pattern, it’s normal for a significant number of market participants to simply wave it off. It’s almost too obvious, and the market never gives us that much visibility. But that’s when you see them come to fruition (interesting reverse psychology, huh?). It becomes so obvious that participants brush it off, because… well, it’s so obvious. The apex of the right shoulder (where we are now) sits right at very significant resistance. Without an incremental positive development in the underlying fundamentals, it will be hard to push above the resistance level.