The market historically trades from supply/demand, buying the rumor/selling the news. When valuations don’t line up with fundamentals, momentum becomes a important factor. The trick to possible outperforming, is knowing when Market momentum may be waning. Those momentum indicators are: Two tech sub-sectors , the NYSE Advance/Decline Line, and Market Sentiment.
Momentum Indicator #1: Sentiment Indicators. Starting with the latter, it’s important to realize that momentum and sentiment, while related, are different. Momentum refers to a state of market psychology where higher prices themselves become the biggest bullish force, as under invested people and portfolio managers chase stocks higher and aggressively buy any dip out of fear of under-performing.
Unlike sentiment, strong momentum is not, by itself, a contrarian indicator (like overly bullish or bearish sentiment indicators). That said, in today’s market, a very bullish sentiment indicator could be a sign of an impending loss of momentum, as the bullish reading implies that everyone is “all in” on stocks, leaving a lack of capital on the sidelines that can “chase” stocks higher.
Right now, despite new highs in stocks, there are few signs that sentiment is near the highs. In fact, sentiment remains remarkably depressed for how strong the market has been in 2017.
The AAII Investors Sentiment Survey showed just 26.9% bulls vs. the historical average of 38.5%(date needed). The TMI Group Market Sentiment Index revealed just 49.8% bulls (the scale goes to 100)(date needed) while the Citi Panic/Euphoria Model remains comfortably in “Neutral” range(date needed).
Point being, if bullish sentiment is a sign of an impending loss of momentum in stocks, we appear to have a long way to go.
Momentum Indicator #2: TECH Sub Sectors One of the reasons we look at sector trading every single day is because every rally is driven by a few sectors, or what we and others call “leadership” sectors. When these leadership sectors falter, that usually implies an impending loss of momentum.
Since late 2016, semiconductors have been the biggest leadership sector in the markets. They rallied big during the Q4 ’16 rally, and they are up big so far in 2017 . While other sector leadership shifted from late ’16 to ’17 (banks and small caps to utilities, consumer staples and super-cap internet) semiconductors have continued to scream higher.
Nearly half of the 2017 S&P 500 rally can be attributed to just a few stocks: AAPL, AMZN, MSFT, FB, GOOGL. Those stocks are heavily weighted in the super-cap internet.( Bloomberg -date needed)
So, these are two important sectors to watch as any possible breakdown could imply a loss of momentum. It happened in the spring of ’14 when the then leadership sector biotech broke down and caused a pullback. It also happened before the pullback in August ’15 when the “FANG” stocks (leaders at the time) topped out in July—a month before the stock market fell.
Momentum Indicator #3: NYSE Advance/Decline Line. We’re not a huge fans of multiple measures of market breadth, but we do watch the advance/decline line, as it gives insight into buyer enthusiasm (i.e. the level of momentum). And, it was an accurate leading indicator in these types of markets (the A/D Line topped out in April 2015, a month before the market topped in May). Right now, the A/D line just hit a new high. But, once again, we’re looking for any signs of a trend break as a sign that momentum is waning.
You’ll never hear me say that fundamentals don’t matter, because they do over the medium/longer term, and that’s what most of us are focused on. Momentum in stocks remains higher still, but getting the break right is key to outperforming.
With stocks this extended, a sharp, nasty and painful pullback is lurking somewhere out there…
Tom Essaye, 2017
Advisory services provided by Rik Saylor Financial, a Registered Investment Adviser. Separate advisory and securities services may be provided by National Planning Corporation (NPC), Member FINRA/SIPC, and a SEC Registered Investment Adviser. Rik Saylor Financial and NPC are independent and unrelated companies. Please consult with your representative to confirm on which company’s behalf services are being provided. Certain statements contained within are forward-looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans, or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. The opinions expressed are for general information only. They are not intended to provide specific advice and do not constitute an endorsement by NPC.