Risk Off Signals Flashing Brighter

Summary

  • Utilities leading S&P 500 is bearish.
  • Lumber signals headwinds.
  • Smart Money vs Dumb Money at extremes again.
  • Retail option traders own a lot of calls about to expire.
  • Bullish top of trend range offers huge resistance.

Watching signals and ignoring the narrative of the day is usually the best thing to do when assessing where we are in a market. We’ve all made the mistake of letting information overload leave us like a deer in the headlights.

Use these signals to shine the light the other way and see what is most likely and least likely. Right now, a correction of some magnitude seems likely.

Utilities Vs S&P 500

When utilities lead the S&P 500 that is a signal that people are becoming defensive. A bearish sign. 

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Lumber

I’ve been watching lumber since the before the financial crisis. It is a good tell on economic strength and expectations as it is so closely tied to housing and business development. There are several relationships to look at as comparisons. The simple sometimes is all we need though. Look at lumber back to before the Financial Crisis.

TradingView Chart Link

Lumber trailing gold is also a bearish signal. That started to occur about 4 weeks ago. It’s not extreme yet, but the trend needs to be watched carefully.

TradingView Chart Link

Smart Money vs Dumb Money

Sometimes it’s this simple. The big guys are selling to the little guys. When has that worked out well? 

I use Sentiment Trader as a shortcut to many studies of correlations. I think this one is among the most telling. 

Sentiment Trader Chart Link

While this is not a sign of a “right now” correction, it is a typical sign of a “very soon” correction. Magnitude is of course always the issue. I discuss that below.

Risky Expensive Option Trades

Not only is the dumb money chasing, it’s doing it with call options. Friday is a big expiration day. 

Sentiment Trader Chart Link

This really think the two Sentiment Trader charts buoy the “greater fool” theory argument. While I just talked about the Millennials starting to take over the market, they have some learning to do. Or maybe some teaching. Well see if they switch to buying puts over buying calls. Here’s the piece that I cover Millennial trading behavior and what might be coming next:

Will Young Traders Flip The Option Switch To Cause A Crash?

Huge Trend Resistance

It is very rare that stocks break out of a long range. This “megaphone” has a clear top end of the range. Getting through the top red line would be extremely unusual, as well as, dangerous. 

The broadening bottom means that there is a lot of room for downside. 

This is a technical formation that almost always leads to a correction. The only question is, how far down. The “orange box” would be standard or typical. Above is very bullish and below is very bearish.

With all the QE, anticipated fiscal stimulus, zero rates for years and likely a new President that trading partners would prefer, the top half of the orange box seems most likely to me. Keep in mind though though downward momentum in a levered and thinly traded market can have a sharp drop, much like March. That would be something to buy with every penny, i.e. bottom of and below the orange box. 

TradingView Chart Link

Bottom Line For Investors

As I have discussed for a few months now, the rally is not supported by the fundamentals. I have even asked: does it matter that stocks are overvalued?

The answer is that at some point valuations will matter. When the reversion to mean occurs, it can be partial, full or overdone. We don’t know which it will be until it gets here.

That’s why we pay attention to technical indicators in real time. As much as we all want to be fundamentalists, the reality is that the sentiments of fear and greed matter in the short run. 

Here is the daily Relative Strength Index. Like the indicators above, it shows we are nearly in overbought territory. Look at what has happened other times this has occurred the past 25 years.

TradingView Chart Link

Keep trimming if you are not to your low equity allocation range and be careful with any purchases – scale in slow. 

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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