Last week, we described our bullish stance, and how we came to that posture over the past 6 months. We continue to see the market as having moderate upside over the next 6 months. Although many factors reinforce this intermediate term perspective, we are rapidly approaching – but not quite at yet – an overbought short term condition.
On the Bullish side of the ledger (intermediate-term), last month presented us with two unusual new data points:
Consecutive 4-to-1 Advance/Decline Days: According to Jim Stack of Investech Research, “for only the 10th time since 1940, the market has experienced 3 consecutive days in which declining stocks trounced advancing stocks by a 4-to-1 ratio (week ending 5/11). This type of heavy, continuous selling tends to be emotional, it usually comes near the end of a decline.” Only 2 of the previous occurrences led to losses 6 months later; In those instances, the declines were 2% or less. Thus, like us, Jim concludes the most recent sell off was extreme in nature.
NYSE Member Net Buy/Sell Data (Weekly): Our second piece of data similarly points to a capitulation in mid-May. NYSE net member buying hit an all time peak for the week ending May 15th. That’s as smart as smart money gets; When NYSE members become massive buyers of last resort, it has been profitable to follow the smart money. A glance at the chart nearby (courtesy of Carl Swenlin’s Decision Point) reveals all three recent examples of extreme NYSE member purchases to be excellent buying junctures.
It is not too difficult to understand why a member-buying spike is perceived as an “extraordinarily bullish event.” It reveals buyers had disappeared – a sign of either fear or loathing of stocks. When NYSE members are forced to step in as buyers, it indicates extreme negative sentiment.
Both of these issues, however, are an intermediate term, three-to-six month perspective. Shorter term, we note that the markets are becoming increasingly overbought, as they have snapped back off their lows. The Nasdaq Comp is now up 7.5% from its May 17th bottom.
We suspect there will be better entry points in the near future than Nasdaq 2000. Investors who are positioned on the long side since mid-May should be patient in adding to those positions. Those who missed the recent lows should make only partial purchases here, adding as the markets work off their overbought conditions, by either pulling back or moving sideways.