This morning, I was asked why I am not jumping in on the upside of stocks after yesterday’s price action especially since I am bullish on the market. It is a great question with a very simple technical answer…The short term trends still favor the bears. In most bull markets, just like we have seen over the past months, there are three major technical trends to be aware of.
- Small cap stocks out perform large cap stocks.
- Trend movement consists of higher lows and higher highs.
- Bonds and the Dollar move lower.
At present, even after yesterday’s rally, all three technical trends favor the bears. This is not to say that by next week we won’t see a reversal, but these are the three key elements that keep me sidelined in the context of the broader market. Below I have hourly charts of the IWM (small caps), SPY (large Caps), and DIA (Dow Industrials).
Note that on the IWM and SPY, the short term highs are getting lower and the short term lows are lower. This is a negative trend. The lower high and lower low trend is not seen as much in the DIA showing that those that are buying are favoring the less risky Dow stocks over the more risky small cap and SPY stocks. The facts that large caps are out performing small caps and small caps are in a short term downtrend are shifts in market dynamics that make me cautious.
The final note of caution deals with the dollar and bonds. During bull markets, the dollar and bonds tend to fall. Recently, both the dollar and bonds have broken significant downward trends as seen in the charts below. The less accurate dollar broke higher before bonds, but bonds followed suit earlier this week. A rising dollar and bond market show investor caution making me a bit more leery about the short term upside in stocks.
So while I believe stocks set new all time highs at some point this year, I am not chasing yesterday’s rally. If the small cap vs large cap and bond and dollar trends reverse, there will be plenty of time to ride stocks higher. The fact that many stocks started to trade back above their 7 day moving averages creates a short term technical contradiction that makes trading lightly the choice for me. I suspect the market will resolve its bullish/bearish mix early next week so for now I stick with a small position in FDX puts that can hopefully make me a few bucks while I wait.