Markets Consolidate Gains – Sentiment Indicators Flash Caution
The Markets for the week ending February 10, 2012 ended up pretty much where they finished last week. The S&P 500 finished down 4 points for the week while the Nasdaq finished down 3 points.
I would like to discuss briefly how sentiment is reaching levels that would indicate that the major indexes are vulnerable to a short term correction – or more sideways consolidation as the Nasdaq works off it’s overbought condition.
Below is a three year chart of the Bullish Percent Index for the Nasdaq. The bullish percent index (BPI) is a market breadth indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold.
As you can see, the Bullish % Index indicator is a contrary indicator – as extremes are reached it has paid to be a Buyer when sentiment is Low and a Seller when sentiment is high.
We also want to consider how far then index has traveled from it’s high to lows or low to highs when making timing decisions. By looking at the chart below, we can see that market sentiment was extremely negative last October – when the Bullish % Indicator was at 22.7 – and when the Nasdaq was down at a 2,260 level. Now today, February 10th – we can see that sentiment is much more bullish, with the Bullish % indicator registering at 62.45% – right at the same time as the Nasdaq is now at 2,903 – about 640 points and 26% higher.
As noted on the Chart – the Nasdaq is also significantly above it’s 200 day Moving average. Historically, this has not been the time to establish new long term Investment positions – better lower risk opportunities should emerge over the 3 – 5 weeks from either a correction or some sideways consolidation action like the past week.
However, as noted in Last weeks post, the long term trends remain very favorable for equities and we would not be sellers of long term investment positions at this time.