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Everyone Knows the Trend Will End

Monday, January 29, 2018
Fred Goodman

But nobody seems to know when.

AT A GLANCE: The S&P 500 is up 26% since last year this date. This is a huge advance, but advances more than twice as large have occurred in the past. What makes this one unusual is that it is happening in a bull market rather than following a bear.



When trades are found for the Discretionary GPS Portfolio by the Goodman Price/Volume Stock Selection System (GPS), they will be listed here. Mental stop losses are updated every week.

You can check the current mental stop losses for all positions held in the portfolio by clicking here.


If you have questions about the GPS that aren't answered in our Frequently Asked Questions pages, please send your questions via e-mail.

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A Bit of History

Rapid advances are common after significant declines but are seldom seen in the middle of a bull market. Also, when they have occurred, the market soon paid a price. Examples can be found following the rallies in 1999, 1987 and 1971.

The market advanced 26% in the year since January 26, 2017. This is impressive, but in the years following 1950, bigger gains have occurred 13% of the time. The largest gains were 66% in the year ending March 2010, and 59% in the year ending August 1983.

However, those gains followed the major market losses in 1981-1982 and 2007-2009. Gains occurring in the middle of rising markets are much less frequent and are often followed by declines.

We can be certain that this advance will eventually end, but betting on when it will happen has very long odds. Large rallies similar to the current one occurred in 1985 and 2013, and it took two years before the piper was finally paid.

Trading Notes

The mental stops for GLD, QQQ and SPY moved significantly higher last week, and even Weyerhaeuser picked up nearly 6%, as the market continued one of the steepest mid-rally advances in memory.

The GPS Program generally selects a stock after a pullback, rather than one in the middle of an advance, so no new selections were made on Friday.

Speaking of pullbacks, the iShares Home Construction ETF (ITB) gave up 2 points last week and is now just 0.81 points above our target of 43-44. We will buy a 4% position if it trades at or below the target, unless the market as a whole is moving lower at that time.

The 50-day moving average for ITB is now in the center of our target, so a good time to buy it will be if it falls below the the moving average and then turns up. If this happens, our mental stop loss can be set just below 42.

A list of current and closed trades appears with the table above at the regular link (Discretionary GPS Portfolio), which you can also find among the links at the beginning of every report.

The indexes finished Friday just as they did the week before -- Dow Transportation and Industrial T++I+, S&P 500 and NASDAQ N++S+. The results for the S&P the next day have been slightly above average (53%).


This configuration has produced somewhat better results than average. Since 1971, the S&P 500 gained the next day 54% of the time.

The most reliable combinations are those in bold type. The very best performers are colored green, while the very worst are in pink. The tables will be updated each week so we can follow the results going forward. Additional explanatory material is posted here, here and here.


General Market Comment

The weekly survey of members of the American Association of Independent Investors (AAII) reveals that 59.8% of them turned bullish just after the new year, the largest number of bulls since 2011. This is not a surprise during a rally as sharp and sustained as is the present one, but in the past, this degree of bullishness occurred very near the top.

The 8-week average shows 51% are bullish, the highest 8-week average since February 2011. That was just three months before the market peaked in May of that year and entered a 19% correction ending that September.

Since 2011, subsequent highs in the number of bulls (black dots below) were also followed by corrections, but they generally took a few months to develop.

The prospect of a three month buffer between now and a correction is not a reason to become complacent, however, since the percent of bulls has already dropped from 59.8% to 45.5% in the last four weeks.

AAII Bulls
Through Friday, January 26, 2018

The S&P 500 MACD indicator continues to explore new all-time highs. It reached 47.66 on Friday, well above its previous all-time high of 34.80 reached March 28, 2000, just before the market tanked.

I consider this record to be a warning that a correction is ahead, rather than a invitation to buy more stock.

S&P 500 MACD (Moving Avg. Convergence/Divergence)
Through Friday, January 26, 2018

I am especially concerned by the very high MACD for the S&P 500 as a whole, in view of the fact that the number of S&P stocks with positive MACDs has not kept up with the index.

In spite of new market highs in all three indexes, the high number of positive stocks in the S&P occurred on January 16 at 357, and it was just 355 on Friday. Furthermore, neither of the previous highs, in December and September, has been equaled.

Number of S&P 500 stocks with positive MACDs
Through Friday, January 26, 2018

The 20-day buy signal from the Dow final hour trading indicator ends on February 1. The S&P 500 is currently 160 points above the price it held on the day the signal was given, so the odds strongly favor another success by this indicator, its 26th out of 29 signals since June 2013.

Dow Industrials final hour trading -- Previous buy signals
Through Friday, January 26, 2018

The 20-day buy signal from the Dow opening thirty minute indicator has a bit longer to run. To be a success, the S&P 500 must close above 2747.71 on February 6. That provides a buffer of 125 points from Friday's close.

This indicator has had six wins in seven attempts since mid-2013, for a record of 85.7%.

Dow Industrials first 30 minutes-- Previous buy signals
Through Friday, January 26, 2018

Economic Indicators

For a change, the S&P 500 earnings estimate for 2018 has been increased rather then decreased. To skip to the technical indicators, please click here.

**************

The P/E ratio calculated from Friday's close, using reported S&P 500 earnings through December, was 24.6. This is well above the median P/E of 20.5 that has been in effect since 1988. If S&P earnings grow by 26.9%, as has now been projected for 2018, the P/E will still be 20.3, even if the S&P sits where it is for the next 11 months.

The chart shows the relationship between current (light blue line) and earlier estimates (thin brown line). At the bottom of the chart you can see the current P/E ratio (light violet) compared with optimistic estimates for the future (purple).

Annual Earnings of S&P 500 Stocks with Estimates Through December 2018

On the positive side, current earnings estimates were just revised higher by 5% over the previous estimate. However, high estimates early in the year are the rule, not the exception. The table shows how common it is to see early estimates lowered as the year moves ahead.

On the other hand, the steady increase in new orders for durable goods in the last three months has returned them to an annual growth rate of 7.4%, up from a negative -2.3% 15 months ago. The Census Department also reports that shipments are growing at an annual rate of 6.3%, its best showing since 2012.

Durable Goods
Through
December 2017

The National Association of Realtors reported a positive annual growth rate in December for existing home sales, its first increase since August. Prices continue to expand at the rate of 4.63% annually, probably aided by a shrinking inventory of houses for sale, which are down by a whopping 10.16% from one year ago.

Existing Homes -- Sales and Price
Through December 2017


Technical Indicators

The VIX Oscillator ended the week neutral at 78.5. It has averaged 78.1 for the last 2 months. The VIX Index has been overbought for two weeks, but it is again correctly priced.

The VIX 3-day buy signal on the S&P 500 ended with a profit of 1.1% last Monday and then met the four rules again on Thursday for another 3-day buy signal. This one will end Tuesday. It will be a success if the S&P holds on to at least some of its present 35 point gain.

VIX Volatility Oscillator Buy and Sell Signals for the VIX Index
Through Friday, January 26, 2018

The three Short Trend Indicators (STI) added another week to the four months during which they have been positive, and they cannot reverse in the the next week and a half. The Swing Indicators (SWI) are also above zero and will not turn negative without a rapid and sharp market loss, or a sustained series of small losses.

S&P 500 Short Trend and Swing Indicators
through Friday, January 26, 2018

In spite of sizable recent gains by the stock market, most indicators are approaching neutrality. However, the Summary Index was built to produce both regular and quick buy and sell signals.

Regular signals have been more effective, but it is unlikely that one will occur for some time. On the other hand, a Quick Summary Index sell signal is on the verge of occurring, since there are now 6 negative indicators, down from just 2 a couple of weeks ago.

A QSI sell signal will occur if one more indicator turns negative, but we will wait until there are at least 10 negative indicators before acting on it.

The SI slipped slowly to 14.60 last week from 15.65. It will continue to fall slowly to 14.25 this week if there are no further changes in the indicators. Currently there are 6 negative, 11 neutral and 12 positive indicators.

Technical Condition of the Market
through Friday, January 26, 2018 >>Learn more

The S&P 500 200-day moving average (green line in the chart above) made another record gain of 12.22 points last week to 2520.50. The previous 5-day record occurred in 1950.

The 50-day moving average (blue line above) also made a record that extends back to 1950, when it added 25.70 points last week to 2691.27. It will take an 11% decline to cause the average to turn lower. This is the biggest drop required to reverse the moving average since April 2016, after the January-February market decline of that year.

As we discussed last week, rapid advances often follow sharp declines, they are less frequent during rallies. In addition to the current one, strong mid-rally advances occurred in 1999, 1971 and 1987 and were followed by extensive declines.

The Trend Indicator (TI) (pink line below) added 0.53 to 15.30 last week, a 4-1/2 year high.

Trend Indicator Long Term History
through Friday, January 26, 2018 >>Learn more

The S&P 500 14-day Relative Strength Indicator (RSI) took out its October high at 86.2% but failed to reach its July 2017 high, so the series of lower highs has continued. The indicator has also made a series of higher lows since February 2017, so we continue to wait for a breakout.

The indicator closed the week at 88.7% and will stay there next week unless there is a significant move by the S&P.

S&P 500 with the Relative Strength Indicator (RSI)
through Friday, January 26, 2018

The S&P 500 Price/Volume Chart has not made a loop in some time. Prices continue to move higher, but volume is neither bullish nor bearish.

S&P 500 Price/Volume Chart
Volume = Total of Individual S&P Stocks
through Friday, January 26, 2018 >>Learn more

The NASDAQ Price/Volume Chart, on the other hand, completed a bullish, clockwise false reversal last week. It is a type of "trend continuation" signal.

NASDAQ Price/Volume Chart
Volume = Published Daily Total
through Friday, January 26, 2018 >>Learn more

The SPDR Gold Trust (GLD) took out its September high at 128.13 when it closed at 128.83 on Wednesday as the US Dollar fell below 90 for the first time since Christmas 2014.

The dollar and the S&P 500 go their separate ways most of the time. The correlation between them is just 4.7%. However, gold and the dollar are inversely correlated by -58.4% -- when the dollar falls, gold has moved higher nearly 60% of the time, as it has been doing recently.

If one multiplies the price of gold by the value of the dollar, most of the fluctuations between them can be masked. It then becomes possible to estimate which is more responsible for variations in the price of gold -- a drop in the value of the dollar or an increase in the real value of gold.

Over the last 20 years, a comparison of the price of gold in the United States and London reveals very little independence. However, in the last 6 months differences have been noted that suggest that more of the recent increase in the price of gold has been due to the fall of the dollar, rather as a result of strength in the metal. This does not bode well for the future of our position in gold. It should be quickly sold if our mental stop loss is violated.

SPDR Gold Trust (GLD)
through Friday, January 26, 2018

The Average Signature continues to reflect market strength. Two of its charts are positive, but the third has not yet produced a buy signal.

Average Signature -- Traditional Method 345 and 645 Triggers
through Friday, January 26, 2018 >>Learn more

Average Signature -- moving averages of the percent > 700
through Friday, January 26, 2018

Average Signature-- Traditional Method 20-day average
through Friday, January 26, 2018 >>Learn more

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Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. To send Fred your questions or comments, click here: Fred@MarketMonograph.com. E-mail sent to Fred may be edited for clarity and brevity and published on this web site, and may include your name unless you request anonymity or specify not for publication. The charts and commentary represent what Fred thinks about the market and what he is thinking of doing for his own account and for accounts he manages at the time of writing. Fred, his clients, or his family may have positions or may make trades in securities mentioned in these commentaries. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. Copyright©2001-2018 Fred Goodman. All rights reserved. For information purposes only, offered as a periodical of general circulation; not to be deemed to be recommendations for buying or selling specific securities or to constitute personalized investment advice. Derived from sources believed to be reliable, but no warranty is made as to accuracy.