Tuesday, May 13, 2014

Tea leaves for a market top?

Calling stock market top is a popular game. As I noted in an earlier post, valuations aren't that good a timing mechanism. So what can a person look for? One thing is for a top in the transports, IYT is a transport etf. The old cliche is "two steps and a stumble," meaning two Fed rate hikes means the end of a bull run. A more modern Fed rule is to look for an inverted yield curve, when short term interest rates exceed long term. This can be on Treasuries or other rates. Right now, short term rates are near zero, so this isn't close. The transports continue to make record highs, so that is not close.

What else? Sentiment. I mentioned the AAII (Association of Individual Investors) weekly Wednesday survey. Again, it is in the mid-range, so it is not flashing a warning sign for a top. Then there is the popular media. A roaring bull on the cover of Barrons or similar publications, or super bull articles as the lead on MarketWatch tend to be a big negatives. I haven't see a bull recently. Then there are the anecdotal indicators. 

In 2013, I came into the year bearish on the stock market, but two separate conversations turned me bullish. Both were with smart, savvy, long time investors, both were ultra cautious on the stock market. One guy wanted to go to all cash, something he had never done in 50 years of investing! That was a huge green light. I would have been a fool to go "all in" based on an anecdote, but it certainly was a factor in me moving away from a bearish stance during a 30% up year.

The caveat is that any and all indicators can fail. A meteor strike or similar out of the blue news event can render all the tea leaves meaningless. In summary, look for the transports to top out first, an inverted yield curve, high bullish readings on sentiment, anecdotal stories of exuberance in the crowd.

/edited to add this section below: technical confirmation is often the final piece of the puzzle for a top. A break below various moving averages confirms the move. The two that I use the most are the 50 day and 200 day simple moving averages. There are a lot more technical indicators, but I don't swim that deep into the charts. 

Some may say that it is late to get out when the 200 day moving average is broken. A person can't always have their cake and eat it. Waiting for confirmation means missing part of the move, and the possibility of whipsaws.

Again in summary:
* watch for a top in the tranports first. IYT may top several weeks or months ahead of SPY.

* watch for an inverted yield curve (short term rates higher than long term rates) 

* watch for excessively bullish sentiment on AAII and in the popular media and websites. Also keep tabs on in person chatter and conversation.

* price movement confirms the top by breaking various moving averages.

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