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3 Signals that Could Be a Turning Point for Stocks

Chad Karnes

The U.S. stock market (IVV - News) gained 6% in January and is off to its best yearly start since 1997. The market continues to shrug off negative news of all sorts.

Case in point: The "surprise" negative GDP number, which has thus far being treated as a temporary, non-issue.  At least that is how the media is justifying the recent miss.  A few of the many enthusiastic headlines are below:

"The Best Looking GDP Drop You Will Ever See" - CNBC

"GDP Unexpectedly Shrinks, Decline Seen Temporary" - Bloomberg

"GDP Decline is a One Off Number" - CNBC"Is It Time To Buy This Rally?" - U.S. News & World

These headlines may sound all fine and dandy, but 83 economists out of a total of 83 economists just missed the 4Q GDP estimate by a mind boggling amount.  If this isn't a negative surprise, I don't know what is! 

Economists estimated a median 1.1% rise in 4Q GDP.  Even the lowest estimate was for a positive 0.3%.  Tell me again why we should now trust these same economists that now say it is "the best looking drop ever" or "a One Off Number" when the closest economist was 0.4% off the actual result? 

If a disastrous miss like this had occurred by a company on Wall Street, its stock would be getting slammed right now (as should economists' reputations).  Like many things on Wall Street, this groupthink of economists looks more like the blind leading the blind than any sort of "expertise". 

Given the fundamentals "no longer matter" and every negative data point is justified with a positive spin, we must therefore turn to other data beyond the traditional fundamentals to help guide us in our investment decisions.

Signal One - Sentiment Extremes

The media's justifications for why the market rises or falls are always after the fact and not based on anything more than rhetoric and possibly even self interest.

The good news is we can actually use it as one of many available sentiment gauges to help us make more informed decisions.  Bullishness abounds in the news, but uber-bullishness, such as shrugging off negative fundamentals, is a warning sign.

Analyzing investor surveys also allows identification of sentiment levels that tell us if we are more likely closer to topping or bottoming.

Right now many signs of sentiment are revealing market participants are as bullish (and long) as they were at the September 2012, the April 2012, and even the summer 2011 market tops (VTI - News). 

This is bearish because it means market participants have already gone "all in long".  At some point there is nobody left to buy and continue to drive prices higher.

Even the media has its own gauge of sentiment for the public. 

CNN Money's Fear & Greed Index is showing the most greed since their index was created, going back to 2010.  It is easy to identify that market tops coincide with these extreme levels of greed and market bottoms are associated when extreme levels of fear are present.

There are many other sentiment indicators we follow suggesting similar optimism and providing warning signals to longer term investors that we are likely a lot closer to a top than a bottom.

Signal Two -The Smart Money

Another data point that the market is likely closer to a top than a bottom is the CFTC's (Commodity Futures Trading Commission) Commitment of Traders report.  The agency requires futures traders to register as either speculators or hedgers.  Historically, speculators eventually lose and hedgers eventually win.

The hedgers therefore are the "smart" money and following whether they are long or short can help keep you on the right side of the market.

Right now hedgers are excessively short.  In fact small-cap (TNA - News) hedgers are so short, they are at levels last seen only at the previously mentioned market tops.  This is a big bearish warning sign.

Signal Three - The Technicals

Although sentiment was and remains extremely bullish, the smart thing to do is to wait for the technicals and price to confirm a trend change before placing a trade based on sentiment.

This is the reason we have remained long since early January, although sentiment remains a huge longer term warning of a top to us.

After the New Year's rally we identified two levels that would help us get comfort with the next trend, either up (SSO - News) or down.  

The following chart of the S&P 500 (SPY - News) accompanied our Technical Forecast on 1/9 and provided that bullish and bearish setup for traders to take advantage of the next market move, which happened to be a breakout to new highs.

Along with the chart above it was identified, "The market isn't falling as much as I expected given the gap higher and exuberant Fiscal Cliff pop, and therefore may want to make one more new high before sentiment and fundamentals take back over.  A break out of the red downtrend line can be bought with tight stops and an expectation of a new short term high above 1465".

This indeed occurred on 1/10 as the sharp snapback "Fiscal Cliff" rally continued its grind higher breaking out of its consolidation at 1463.  The rally still continues today with the S&P now around 1500. A recent chart provided in our Technical Forecast below, shows the history of the uptrend along with the stop levels we set along the way.


Although sentiment and complacency (VXX - News) is extremely bullish and at levels associated with market tops, the short term technical picture remains bullish, for now.  Our stop is now in an area that locks in a nice profit and will warn us of an impending trend change from up to down. 

Given the deteriorating fundamentals, the overall extremely bullish sentiment, and the smart money shorts, we are, however, extremely cautious over the medium term.  A breakdown in the short term technical trend identified in the ETF Profit Strategy Newsletter likely will set up an opportunity to buy the ProShares Short S&P (SH - News) or the ProShares UltraShort ETP (SDS - News) to take advantage of the trend change from up to down.

Once the technicals confirm this top, the likelihood of a larger selloff will be very high given the extremely bullish sentiment that exists potentially adding fuel to a selloff fire.

TheETF Profit Strategy Newsletter uses common sense technical analysis combined with sentiment and fundamentals to provide a short, mid, and long-term forecast along with actionable buy/sell and target recommendations.

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