How Much Further Will the ‘Smart Money’ Chase Overpriced Stocks?

by Sam Collins | November 5, 2013 2:41 am

On Monday, blue-chip stocks sold off on the opening but recovered following the lead of small-cap stocks. But it was a sluggish day of trading with volume at slightly below average.

The Wall Street Journal reported that with 75% of S&P 500 companies having reported Q3 results, they are on pace to deliver year-over-year earnings growth of 3.1%. But concerns surfaced that the Federal Reserve would decide at its December meeting to taper its bond purchase plan.

At the close, the Dow Jones Industrial Average rose 24 points to 15,639, the S&P 500 gained 6 points at 1,768, and the Nasdaq jumped 15 points to 3,937. The NYSE traded 661 million shares and the Nasdaq crossed 442 million. Advancers outpaced decliners by 2-to-1 on both exchanges.

Dow Chart
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Chart Key[1]

The Dow industrials have pounded against the narrow range of 15,660 to 15,721 for six months. Meanwhile, its companion index, the transportation average, scored another new high Monday, putting the industrials in the curious position of creating what is called a Dow non-confirmation.

Note that MACD is turning down again, and that usually signals that the industrials will pull back again.

Nasdaq Chart
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And while the blue chips lag, the Nasdaq has been setting new highs monthly. Now, however, note that following the last high, MACD flashed a sell signal.

Conclusion: Even though volume was low Monday, it appears that new money is again going to the small-cap and mid-cap stocks. With just a few days of pension money flowing into institutions, they must decide how to allocate it for the best return. Thus, the Dow industrials have little time to dawdle at the top of their range before the flow dries up and the index sinks.

It has been a spectacular year for the Nasdaq and the small caps. But P/E ratios are skyrocketing in the tech sector, and I wonder how much further the “smart money” will chase a group of overpriced stocks. Given the MACD sell signal on the Nasdaq, we should at the least expect a pullback to the 50-day moving average at just under 3,800.

One final note about Monday’s happenings: The Federal Reserve trotted out two of their heavy hitters, St. Louis President James Bullard and Dallas President Richard Fisher, to remind us that it will eventually start reducing stimulus. And Bullard even said that it was “certainly possible” that the bond purchases could be pared back after the next Fed meeting on Dec. 18.

Right, when cows fly! This is likely just more Fed jawboning that indicates they think the markets are getting a bit overheated and don’t want the blame for a big run up from current levels and a subsequent deep correction.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[2].

For a list of this week’s economic reports due out, click here[3].

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