Another Buy Signal—Almost

11/04/2010 1:00 pm EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says the market has been marking time waiting for the Fed’s decision, announced Wednesday, and may be poised to break out of its trading range.

While waiting for the Federal Reserve’s next move (it said Wednesday it would pump $600 billion of new money into the economy—Editor), the market held on to its earlier gains, but has turned somewhat indecisive: Over the last [several] trading sessions, the Dow Jones Industrial Average has actually been locked in a very tight trading range bounded on the high side at 11,247 intra-day and the low side at 10,917.

Over this period, the Dow has only gained 0.27%, [but it] has remained consistently above its up trending ten-day moving average for most of this rally. It moved above it for the first time on September 1st, and during the 40-plus trading sessions that have taken place since that date, it has dropped below it on only three occasions: October 4th, when it closed -0.3% under its [ten-day moving average]; October 19th, when it finished -0.5% under; and October 28th, when it closed a little over a point below its [ten-day moving average].

Note how it bounced back after the two previous penetrations. This is indicative of a market that has been under persistent accumulation.

Some analysts have commented that a number of sentiment gauges have turned top-heavy to the bullish end of the spectrum. For example, the American Association of Individual Investors’ (AAII) weekly survey reports that bullish sentiment has risen to 51.23% in its [last] poll. That’s the highest reading since May 2008 and well above its historic average of 39%. As a contrarian indicator, the increase in optimism suggests a topping market.

Interpreting market sentiment indicators, however, is often difficult. First, there’s the problem of determining exactly what are extreme levels; and second, [which] indicators best reflect the overall sentiment of investors.

Painting a somewhat different picture of investor sentiment is the Rydex Asset Ratio. We like it because it tracks daily inflows and outflows of real money being invested in the Rydex funds. Investors have become increasingly more bullish throughout the rally, but [the indicator] remains well below its peak readings seen earlier in the year. Based on this one indicator, at least we have not seen extreme levels of bullishness.

No one can argue that the rally has not been impressive. Since August 27th, the Dow has jumped 1064 points, +10.5%. Over the same period, the Nasdaq Composite Index has surged 18%, followed by the Russell 2000’s 16% [gain]. Buying pressure has been most persistent. Corrective activity continues to be extremely shallow and over very quickly.

The longest pullback since the August lows lasted only four trading sessions, with the Dow losing less than 1%. What we have here is a market that just doesn’t want to go down, and yet our models continue to exhibit caution. On a scale of 1 to ten, ten being a Buy signal, they are registering an eight.

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