Getting Ready to Shift from Yellow to Green

Sell off enters 9th inning: Oil price shocks, terrorism, geopolitical unrest, valuation issues, CEO prosecutions, domestic political concerns, assassinations, bond bubble, interest rate issues, job worries – and that’s just the news. We also have seen complacency, rampant speculation, and excessive optimism (though hardly anymore). Have I left anything out? Oh yes, the technical breakdown of the major indices.

With all that to digest, it is hardly a surprise that the markets have resumed their consolidation as we are about to enter into the pre-announcement season. As we have mentioned previously, the recent weakness is more a result of deteriorating technical conditions than headline driven selling. Regardless, whatever gets us to a preferred buying juncture works for us.

We see several signs that are moving us off our Yellow alert of January 22nd: The recent up tick in Money Supply typically bodes well for the market a few months out. That suggests another leg upward. The increase in money supply began in January, and has continued in earnest through the entire first quarter. We expect the impact of this increase will be felt by the markets shortly – in our opinion, sooner rather than later (the latest being the start of the 3rd Q).

We are approaching the levels of support mentioned previously. It would help to see fund inflows rise, but that would be more of a sentiment function – which itself is tied to whether markets are rising or not. (Welcome to the hall of mirrors!).

Last, we note that the advance/decline ratio is better than 9 to 1 negative. That sort of indiscriminate selling is often what accompanies a panic low (intermediate term or better). From a contrarian perspective, this is another indicator that the selling is getting overdone, and makes us more comfortable in stepping to the buy side of the aisle.

Your response to the sell off should depend most of all on your risk tolerance. Aggressive buyers should begin scaling back into the markets between the present levels and the support levels we’ve been harping on: 1875 on the Nasdaq, 9900 on the Dow, and 1070 on the SPX.

More conservative investors – those with shorter timelines or greater risk aversion – should wait for a high volume reversal day. That will be any trading session where we see significantly above average volume as the markets sell off, reverse, and close higher. Look for volume to be roughly 20% above the past 30-day average, and a swing of 3% (i.e., down 1.5% to up 1.5%.)

UPDATE: 2:31 PM
We now see better than 10 to1 negative volume on the NYSE (90.6 to 6.9), and on the Nasdaq (57 to 4.7).