"If it looks great, it's too late." That's the phrase on a button I am quite fond these days. So, yes, it's no surprise to longtime readers that I would rather look at a set of indicators on the market than a chart of the S&P 500. Don't get me wrong, I like charts, but I prefer indicators to help me with the market.
Why? Good charts can turn bad and bad charts can turn good. I have even turned a chart upside down to see if perhaps we are being too biased, just based on a price chart.
Consider this: A week ago, I posted a poll on Twitter showing the chart of the Russell 2000 -- this was before the rally the last two trading days last week - and I asked if folks preferred the head-and-shoulders top or the head-and-shoulders bottom. The poll was split right down the middle at 50-50.
Quite frankly, the chart hasn't changed that much since it has basically made a round trip in just over a week, from $155 to $151 to $155 on the iShares Russell 2000 (IWM) , an exchange-traded fund for the Russell. Below, I have drawn in the potential head-and-shoulders bottom, with the black line as the neckline. I have also drawn in the head-and-shoulders top with the red line as the neckline.
Do you see that rally in early May? The one that poked up over the line? You might recall fewer stocks were making new highs, the McClellan Summation Index was heading down and sentiment was more than complacent. In my view there were a lot of negative divergences at that "breakout."
Now look at late May, where I have RS? to denote a possible head-and-shoulders bottom. We broke down from a top of sorts, perhaps a truncated head-and-shoulders top. But as you might recall, we had fewer stocks making new lows, we had a deep oversold condition and we had sentiment seriously bearish. In my view it looked like a false break down.
So, when I say to you that I look at this chart of the IWM, and if it rallies up over $160 as we get intermediate-term overbought -- which I expect around mid-July -- and fewer stocks make new highs and sentiment is too complacent, I will not be encouraged by a breakout, but rather will think we've gone far enough and it's time to turn back down.
I can do the same exercise with the Transports that everyone hated midweek last week. The chart of iShares Transportation Average (IYT) , an exchange-traded fund for the Transports, is a bit different, but the two patterns are there. Here the pink line around $190 represents resistance, and also the same high as the left shoulder. If you just looked at the chart, you'd have to give up on your bearish view if it got over $190, wouldn't you? But what if it gets over $190 and there are a host of negative divergences in the indicators? I would think then you'd have more reasons to be bearish, not fewer.
So I will stick with the indicators, which didn't change drastically from Friday's action. I'll monitor the number of stocks making new highs as we head toward intermediate-term overbought, because if there are fewer than 323 on the New York Stock Exchange, that would be a negative divergence. Friday saw 164. I'll also continue to monitor the put/call ratio's 10-day moving average, which continues to slip into complacent territory. But for now those are the only indicators that show signs of possible changes.