BarroMetrics Views: S&P & Context

On the surface, there is mounting technical evidence that a top is in the making in the S&P. Figure 1 shows cash S&P. It made on new reaction high on Friday, and yesterday we saw a narrow range day on below normal volume.

Normally, I would consider this bearish - new breakout high, no follow through.

In addition, the sentiment indicators I use are shouting ‘top! For example the ‘Smart, Dumb Money’ Indicator by Sentimentrader, Figure 2. With this indicator both the spread and overbought/oversold regions are important. On Friday we saw the Smart Money at 60, the Dumb Money at 40 and with the spread of 20, the minimum spread for this indicator that suggests a top.

But these are not normal times.

  1. The reason why Figure 1 is a bearish pattern can be found in Auction Market Theory. Normally, higher prices attract sellers, and discourage buyers.  
  2. In an uptrend, once there few buyers at a price, the natural weight of attracted sellers causes a correction or change in trend. 
  3. A low range and volume after a breakout signals lack of demand, and we expect to see sellers come in.

But, the pattern assumes sellers will come in at the higher price - sellers are necessary for a sustained down move to occur.

The problem is the FED’s QE has discouraged sellers by fostering a belief that the FED can prevent any severe correction.

Rob Hanna has done some great work in this respect.  I find his QE Short-Term  Buying Power (see Quantifiable Edges) indicator of great assistance. Figure 3 shows the indicator at +5.0. This means that in the short-term, the FED is flooding system with liquidity that tends to flow into the stock market.

Under these circumstances, we may not see a correction.  After all, with buyers absent last night, it was an ideal time for sellers to come in - yet they did not. That’s not to say they won’t tonight. But, the longer they stay away, the greater the probability that buyers will re-assert control, and we see a resumption of the uptrend.

We have seen it all before. Figure 4 is a weekly chart of the cash S&P. The green lines below the candlesticks are a moving average of the true range and a moving average of the volume.

It shows that the latest series of  up waves were characterised by declining volume and range. A correction was brought about by external events that undermined the belief in the FED’s ability to keep the stock market afloat - the European Crisis and The Fiscal Cliff.

Eventually, of course, the belief in the FED will prove false. But, until then, I am either out or long so far as the S&P is concerned.

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FIGURE 1  Cash S&P Normalised Volume

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FIGURE 2  SMART-DUMB

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FIGURE 3  QE Short-Term Buying Power

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FIGURE 4 S&P Weekly

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