Friday’s fierce rally makes me wonder if it’s something simple like window dressing by the funds, or if there’s some major event or decision in the works we don’t know about. Window dressing will end today, and from there we could see some profit-taking. But for all we know, Obama could be extending the tax cuts for everyone or cutting payroll taxes.
It would only take one of these events to trigger a sharp up move in the market, and that could be what Friday’s move was anticipating. That being said, volume has remained light, and during low-volume sessions the market has a tendency to move higher. Sell-offs in the market require strong volume to pull the market down, so until volume picks up, there could still be higher prices just around the corner.
To get a clearer picture, let’s turn to the charts.
The Market
Last week, we saw the market reverse to the downside with a strong end-of-day sell-off. That set the tone for some follow-through selling and for any bounces to be sold into. However, the market always has a way of surprising traders, and it did just that on Friday, gapping above Thursday’s reversal high, causing shorts to cover and the typical end-of-week light-volume drift to help hold prices up. You can see this in the chart of the SPDR S&P 500 ETF (NYSE: SPY) below
SPY 60-Minute Intraday Chart
Market Internals
I like to follow some market internals to help understand if investors are becoming fearful or greedy. It also helps me gauge if the market is overbought or oversold on any given day.
The three charts below show some interesting data:
NYSE Market Internals 15-Minute Chart
Top Chart — This indicator shows me if the majority of shares traded are bought or sold. When the red line spikes up and trades above 5, then I know the majority of traders are buying over covering their shorts. I call this “panic buying,” because traders are buying in fear that the market will continue higher and they will miss the train. When everyone is buying, you know a pullback is most likely to occur.
Middle Chart — This shows the NYSE advance/decline line. When this indicator is below -1,500, then the market is oversold and bottom pickers/value buyers will step in and nibble at stocks. But when this indicator is trading above 1,500, then you know the market is overbought and there should be some profit-taking starting soon.
Bottom Chart — This is the put/call ratio and it tells us how many people are buying calls versus put options. When this indicator is below 0.8, more traders are bullish and buying leverage. My theory is if they are buying leverage for higher prices, then they have already bought all their stocks and now want to add some leverage for more profits. When I see the majority of traders bullish, then I am sure to tighten my stops (if long) as a top may be forming.
When each of these charts is trading in the red zone, I know I must be cautious with any long positions because the market may be starting to top, or a short-term correction may occur.
U.S. Dollar
The U.S. dollar has been under some serious pressure with all the talk about quantitative easing (printing money). Obviously, the more the government prints, the less value the dollar will have.
The chart of the PowerShares DB US Dollar Index Bullish Fund (NYSE: UUP) below shows a green gap window that, once it is filled, should put the dollar in a oversold condition for a short-term swing trade bounce before heading back down. A bounce in the dollar will put pressure on equities, gold and oil.
UUP Daily Chart
Gold
Gold continues to grind its way up, as you can see in the chart of the SPDR Gold Trust (NYSE: GLD) below. This move is looking very long in the teeth and a pullback will most likely be sharp.
GLD Daily Chart
Market Outlook
In short, equities and gold continue to grind their way higher while the U.S. dollar continues its grind lower. When I say “the market is grinding,” I am implying the market is overextended and a reversal should occur any day.
Financial stocks like Goldman Sachs Group, Inc. (NYSE: GS), which typically lead the market, have been underperforming significantly over the past week. Insiders were selling GS, which is strange and makes me wonder what’s going on? With the financial stocks underperforming, it sure looks like a market reversal is just around the corner.
If Friday’s rally was simply window dressing by the funds, then it should end today, and we will see a sharp reversal to the downside early this week.
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