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Be Cautious As Stock Market Internals Are Deteriorating – Mike Swanson (07/19/2021)

I am testing a new theme/look for this website. I actually am planning to make a lot of changes and additions to the site over the rest of this year, but step one is to improve the overall look of it, including making it easier to read. I think this font on this post is better than the ones used previously. Everything seems to be working fine with the new theme, but if you have any problems please let me know through the contact form.

I came into this year roughly 50% invested in the markets, including gold, commodities, and stocks, and 50% in bonds. As the year began I let those bonds expire and by the start of the summer got to be about 70% invested in the financial markets. Last week I paired my allocation back down to 50% “risk” and 50% cash for now.

I believe the risks are growing in the markets for a correction before the end of this year. Now we are at the start of earnings season and typically the market will rally during the first 2-3 weeks of earnings and that can still happen. We may bounce back up a little this week. In fact key stocks to watch for a turning point include MSFT, APPL, and GOOG as they are now leading the S&P 500 and report earnings at the end of this month.

We’re likely not at the start of some big plunge immediately, but at the start of some sort of stock market topping process that will play out over a few weeks. The stock market internals are now deteriorating and this is a big danger sign that suggests that the overall risks in the markets are now increasing. What this means is that many stocks are now fading and the S&P 500 is being pushed up by fewer stocks.

Check out these charts to see what I mean.

Let’s start with the S&P 500.

Now I was thinking the biggest danger in the markets would be if the S&P 500 went up like it did last year in August to get so overbought that its RSI reached 80, to an extreme. It got overbought at 70, but didn’t hit 80. It could, but it doesn’t have to for a correction to happen.

Typically every year the stock market will pullback 10%, at least once, even during a bull market. That’s what happened last year in September, and when pullbacks happen things like crypto get totally crushed and fad stocks get hit hard.

It would be nothing – and be normal – for the S&P 500 to go down to its 200-day moving average, which is the green line on the chart and would take a roughly 12% pullback from its high.

But the real danger sign is the simple fact that while the S&P 500 has been strong, since June, most stocks have actually weakened to cause the internals to fade. Take a look at the Russell 2000.

The Russell is actually trading on support.

The more important NYSE composite, which is basically every single stock in the market also made a peak in early June.

Now this is the key indicator that is flashing a huge warning sign. This is the internals for the S&P 500. It is the percentage of stocks inside of it above their 200-day moving average. As the S&P 500 made a new high this indicator went down.

When market rallies narrow to just a few stocks that is how they come to an end. Another way to look at this is the advance/decline volume line. This measures the up volume and down volume going into the market. It’s been going down the past few weeks, even though the S&P 500 made a new high.

If you just look at this chart in comparison with the first chart, which is of the S&P 500, in this post you can see at a glance what is happening.

Of course, if the market does pullback the things that will fall the most are the fad stocks ALREADY lagging the market badly. Such stocks dominate the Robinhood top 100 list and are typified by such ETF’s as ARKK.

And, of course, we have seen Treasury bond yields mysteriously fall, even though inflation is here and the economy has been growing fast in terms of GDP over the past six months. Their drop suggests that the rate of growth has peaked and money is flowing into them, for now, for safety. Risk-off markets are what corrections are about. If the market does correct before the year is over the media will point to news stories to of that moment to explain the reasons for the decline, but the reasons will be right here in this post – internals faded, market rally came to an end.

That said, this post is going to make a lot of people angry. Most individual investors right now are fully invested in the markets or are still chasing fad stock plays or even worse playing Bitcoin. The Investors Intelligence survey shows that most people are wildly bullish. This is the best and most useful survey for sentiment I know of and readings above 50% indicate extreme bullishness. It’s not a perfect timing indicator, but this survey has never gotten above 65% and last week showed that over 60% are bullish.

No one is going to tell you to sell. Even if a stock trading pro believes the stock market is going to decline he has no incentive to try to warn people, because all he will get is anger and backlash. And if he says it on TV he may not ever be asked to be back on ever again – because it hurts ratings. We live in a time now more than ever in which people only want to hear what they already believe and some get triggered when they hear something that is not what they want to hear.

I was hoping to sell later closer to an exact top, but you can’t rely on getting out on the day the markets top and just decided that reducing my own risk, for now, by cutting my stock exposure to 50% makes sense for me. I don’t think ANYONE should be on margin in this market or taking big risks. But deciding how much you want in stocks is a different story and decision you must make. Where I live a lot of investment advisors tell people to have 50% in stocks at all times and the rest in bonds and then when the market drops and their stock allocation goes down to 40% or 45% they can buy more to get that back up to 50%. Personally, I think bonds make no sense as long-term investments and like gold, silver, and alternatives, but the point is I think 100% stocks is risky now and I paired back my own stocks/risk allocation and will be looking to use cash reserves I created now to buy in the future. And if it keeps going up, I’ll live with it and just be patient.

There are no bears in the market when Investors Intelligence comes in under 16%.

Crypto is NOT a safe haven, as I explained in the video I did yesterday.

Want to learn about my trading methods? Then grab my book Strategic Stock Trading.

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-Mike

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