A Different Breed of Bull

Here is just one subsection of this weekend’s Weekly Strategy Session, which I published and sent out to members earlier on Sunday, which puts the current market’s run in perspective.

Keep in mind, the rest of the Strategy Session is devoted to specific, actionable trading ideas with sector rotations and price levels to watch, in addition to educational material and broad market context in the form of thorough current relevant issue coverage. 

1. The Uniqueness of the Current Bull Run 

To give you an idea of the abnormal and indeed historic nature of the rally we have seen in 2013, let alone since March 2009, let us begin by looking at a quarterly chart of the S&P 500 Index. With this most recent push higher into mid-May, price has now punctured its upper quarterly chart Bollinger Band, which is obviously a very long-term chart spanning several decades (Bollinger Bands can be useful technical indicators for measuring, in part, relative tops and relative bottoms, as well as signs of abnormal strength or weakness).

True, price did “ride along higher” its upper quarterly chart Bollinger Band throughout the middle years of the 1990’s, which is another lesson to drive home that puncturing the upper Bollinger Band on a long-term chart is often a very bullish sign of things to come down the road. But it does mean to not walk away from your computer screen in the short run, as the rubber band can snap back violently at any time in form of an aggressive correction.

What you will notice is that neither during the final years of the 1982-2000 secular bull market, nor throughout the 2003-2007 cyclical bull market did price even touch precisely, let alone puncture through, the upper quarterly chart Bollinger Band.

In other words, the strength we have seen out of this current market is rare and either currently or rapidly approaching long-term overbought conditions of a unique and perhaps unprecedented nature.

So, the rally is too overheated and simply cannot continue on higher next week, right? Well, not quite.

When we zoom all the way in to see the daily chart for the S&P, price is not overbought according to Bollinger Band analysis. There is room to push higher yet next week, before even a reasonable analysis on this timeframe could conclude that the market is “overbought.” While it is true that we need not become overbought before topping out, the powerful and unique trend this year has rendered those types of bearish theses to be null and void…for now.

Furthermore, other technical indicators like the RSI of major index charts, while overbought mildly, are not so dramatically overbought as to justify calling a major top.

In addition, the NYSE McClellan Oscillator (“NYMO”), which is a simple market breadth indicator tool, is also showing a lack of overbought conditions headed into this week. Generally speaking, when NYMO is above zero it tends to indicate bullishness for stocks, and below zero, bearishness. However, extreme readings can indicate overbought or oversold conditions. Above 50 is considered to be overbought, while below -50 is considered oversold.

As you can see on the daily chart of NYMO, last week’s close of 16.61 gives plenty of room for another push higher in stocks before hitting overbought conditions, above 50.

Bears will argue that the above NYMO chart amounts to a bearish divergence to stocks, since NYMO has been falling throughout most of May, while we know the equity markets have rallied to new highs. Furthermore, bears may make the same argument with the longer-term versus short-term Bollinger Band analysis, discussed above. However, as we have seen many times in 2013, these divergences could just as easily resolve in favor of the prevailing trend higher in stocks.

The increased speculation into higher beta, smaller cap, and heavily-shorted issues and sectors (e.g. China stocks, solar, shipping) continues to be consistent with a maturing rally. But just because a market is long-term very stretched with hallmarks of froth underneath the surface does not render declaring an imminent top any easier. Recall that markets which trend higher are uniquely difficult in which to declare a major inflection point at hand, perhaps even more difficult than declaring a bottom in a corrective or bear market. Instead, traders would likely be best served to focus on their risk-to-reward ratios in terms of which stocks and sectors to play and how aggressively to play them as a maturing rally becomes even more stretched.

Thus, the suggested strategy headed into this week remains putting in the work to identify stocks which fit within the template of a sound approach, which we will do in detail in the next several subsections. In other words, swing traders should continue to look for stocks which are setting up properly and not yet extended, instead of throwing all caution to the wind and aggressively chasing issues which have already become too far stretched away from reasonable swing entry points (several days or even weeks extended up past a 20-day moving average, for example).

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(As a reminder, members of the 12631 Trading Service inside The PPT receive the Strategy Session included in their membership at no additional cost each and every weekend.)