Executive Summary:
As I have mentioned a time or two, "early warning" or mean reversion work tends to be more art than science. The main problem is that strong trends will reach an "extreme" overbought/sold reading and then stay there for some time. As such, it is important to identify if the current market is in what I call a trending mode. To be sure, the bulls trended higher from late June through the start of September. However, the rather violent pullback that ensued forced my regime indicators back to a "mean reverting" (or non-trending) mode. For shorter-term traders, this means that one should "look alive" and be ready to move once overbought/sold levels are reached again in the oscillators. Such was the case recently as an oversold buy signal was flashed. However, it appears that signal is now being reversed. From my seat, the bottom line is that some additional downside exploration looks to be on the menu, which will likely lead to a solid buying opportunity.
Now let's take a look at our Early Warning Board for clues about the near-term action.
The State Of Early Warning Indicators
At first glance, there doesn't appear to be meaningful changes to the Early Warning Board this week. Sure, some of the indicators have traded places and there are now fewer buy and sell signals on the board. However, if you look closely, you will find that the Intermediate-Term Sentiment Model upticked to a buy signal. This means that sentiment has reached negative levels and is now reversing. And when this occurs, the hypothetical annualized historical return of the S&P 500 has been a very strong +30.4%. In addition, the board's hypothetical annualized historical return has improved to +14.3% from +5.3% last week. Therefore, I will opine that while there could easily be some additional downside in the near term, the market looks to be in the process of setting up an entry point.
Early Warning Indicators. Early Warning Indicators.
Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability..
Stochastic Review
As I mentioned above, the buy signal on the stochastic indicator shown on the chart below recently flashed a buy signal. However, it appears that signal may be reversing. And if this is the case, then investors looking to buy stocks will be looking for the next setup. In short, I like to see the blue line move below both the red line and the 20% level, and then reverse. While not a perfect signal by any means, such an approach may tilt the odds in your favor if used consistently.
S&P Daily Chart. S&P Daily Chart.
Thought For The Day:
Kind words can be short and easy to speak, but their echoes are truly endless.
- Mother Theresa
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