The Week Ahead: Why Following the Crowd Can Be a Bad Idea

06/06/2014 5:15 pm EST


Thomas Aspray

, Professional Trader & Analyst

As the strong jobs report on Friday translated into another round of all-time highs in the major indices, market participants are finding it even more challenging than usual, so MoneyShow’s Tom Aspray advises doing your own analysis diligently and avoid following the herd.

The stock market punished more of the stock market bears last week as the Dow Industrials, S&P 500, and Nasdaq 100 reached levels that should have hit any conceivable stop loss orders of those who were short. However, many of the longer-term bears do not use a stop, which in my opinion is the fastest way to wipe out an account. Risk on either the long or short side needs to be managed at all times.

This has clearly been a tough year for the investor as the bullishness at the end of 2013 was followed by periods of non-trending price action in market-tracking ETFs like the Spyder Trust (SPY). Even the pros were being chopped up as several who generally avoid the media commented that it was the toughest market they had seen in many years.

In last week’s column, I proposed a dollar cost averaging strategy for several large ETFs that should have been started last Monday. Four more equal dollar investments would be made on 6/23, 7/14, 8/4, and 8/25 (Editor’s Note: the dates have been corrected from last week’s column). I continue to think this is a good way to become invested and lowers the chance that you will be getting in at the top.

One well-known hedge fund manger spooked the market with his comments on May 14 as the Dow lost around 170 points the following day, but bottomed out four days later. He apparently is no longer “nervous” after the ECB rate cut on Thursday. I have also cautioned investors not to follow the crowd or any one advisor. It has always been my goal to help my readers learn how to become their own expert advisor.

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The sentiment data from the American Association of Individual Investors (AAII) is released each Thursday and often gives a good reading on what the crowd is thinking. As is the case with most sentiment data, it needs to be combined with other technical measures like the NYSE Advance/Decline in order to identify turning points in the market.

I have noted some of the AAII readings since the bear market low in 2009 when the March 5 survey revealed that only 18.9% were bullish. Those of you who follow the markets may remember that there have been several extremes in sentiment as the bull market has progressed.

For example, in July 2010 the % dropped to 20.9%, and then six weeks later (8/26/10) was at 20.7%. Less than two weeks later, the A/D line had surged to new highs indicating that the market’s uptrend had resumed. By the end of the year, 63.2% were bullish. The stock market kept moving higher and added another 10 S&P points or 8.4% before it topped out in late April.

In early August of 2011, as the US debt was being downgraded, the bullish % dropped to 27.1%, and six weeks later as many were talking about a new recession, it hit a low of 25.3%. The upside reversal on October 4 and bullish A/D readings indicated the market had bottomed. By February of 2012, there was quite a change as 51.6% were bullish. The SPY topped out in early April.

The selling in May was quite heavy as the Euro debt crisis spooked investors and the market bulls ran for cover. By the middle of the month, only 25.3% were bullish. As was the case at the 2010 and 2011 lows, the technical studies suggested a bottom was in place by early June and the bullish % had only risen slightly to 27.4%.

At the end of January 2013, the AAII reported that 52.3% of individual investors were bullish but the market climbed higher for the rest of the year with little in the way of a correction. Despite the strong market, the number of bulls dropped below the 30% level several times over the next 11 months before hitting a high of 55.1% at the end of the year.

In 2014, the late January-early February decline caused a crisis in confidence as by February 6, only 27.9% were bullish. As I noted in a recent trading lesson Profiting from Panic Selling, the Arms index indicated there was panic selling on February 4.

The choppy trading in April and May dropped the bullish percentage below 30% on three occasions with a low on April 17 of 27.2%. As of last Thursday, 39.5% are now bullish. I generally look for a reading under 30% and over 50% as a reason to keep a closer eye on the technical indicators for signs the market is turning.

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Every year, there are often signs that a market is becoming one sided. In a March 21 Wall Street Journal column, they quoted statistics from Japan’s finance ministry that foreign investors had sold $11 billion of stocks the previous week, which beat a record going back to 2005. The chart also shows that the number of bearish bets on the Japanese market also hit a multi-year high. This was a good reason re reconsider any thoughts about selling.

At the time, the Nikkei 225 was trading around 14,200 and dropped to a low of 13,885 three weeks later. It is now about 1,000 points higher or 5.6% above where it was when the article was published. The WisdomTree Japan Hedged Equity ETF (DXJ), part of the Charts in Play Portfolio is up just over 7% since the article.

NEXT PAGE: What to Watch


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The threat of deflation has been looming over the Eurozone for some time, and late last year, I thought it might be a reason for the Fed not to taper, but I was wrong. This chart shows the clear downtrends in the inflation rates of Germany, Spain, Italy, and the Eurozone. All are well below their target level of 2.0%.

If the US had taken the same austerity route as the Eurozone, we might be facing the same dilemma, and there are few remedies for deflation. Those who have been criticizing Bernanke from the start should think about this and also what happened to the US economy in 1937 when we stopped easing too early.

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Therefore, the action by the ECB to drop a key interest rate below zero was widely applauded by the world stock markets. It is hoped that it will stimulate the banks to offer more loans. They also seem ready to take further action if it is needed. The inflation-adjusted key lending rates in both the Eurozone and US are both now below zero.

Even though the bond market has been much stronger than I expected, so far this year, I continue to favor stocks over bonds. There are now some early signs that the bond market may be topping out. Given the US annual inflation rate of 2%, a 10-year T-note yielding 2.58% does not give one a very attractive real return.

As I have expecting for the past several months, the economic data has continued to get better, and this needs to continue for the next month or so to convince the majority that the current high stock prices are justified.

The ISM Non-Manufacturing Index was stronger than expected last week while the Manufacturing Index was only down slightly. Factory Orders were strong and the Global Manufacturing PMI also reflected further expansion in global manufacturing.

This week, I will be watching the Retail Sales report on Thursday for signs that the consumer is shopping once more. Also out are the Business Inventories, along with Import and Export prices. On Friday, we get the preliminary reading from the University of Michigan on Consumer Sentiment.

What to Watch
In last week’s analysis, I suggested that “The confirmed upside breakouts suggest the surprises may be on the upside.” This has certainly been the case with S&P 500 now getting closer to its monthly projected pivot resistance at 1977. The technical studies have confirmed the new price highs though prices are a bit extended with the S&P 500 now 4.5% above its 20-day EMA. This is certainly not a time to be chasing prices, though surprisingly, there are still some stocks that just bottomed out this week.

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As I noted earlier, the sentiment levels do not yet signal too much bullishness but the five-day MA of the % of S&P 500 stocks above their 50-day MAs has risen further, now at 73.94%, which is not far below the one standard deviation level of 79.2%. It is well above the mean at 64.2%. The pattern of higher lows, line a, is positive and it could rise to the high risk zone at 80-85%.

For the Nasdaq 100, the % has risen above the mean at 60.6% and is now at 68.7%. It has not been above the 78% level since early in 2013.

The weekly chart of the NYSE Composite (NYA) shows the breakout above the trend line resistance at line a last week. The quarterly pivot resistance (red line on chart) is at 11,087 with the pivot at 10,270. This level was tested during the April decline but there was not a weekly close below this key level.

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The rising 20-day EMA is now at 10,711, with the June monthly projected pivot support at 10,678. The monthly projected pivot support is at 10,596.

Both the weekly and daily NYSE Advance/Decline lines made further new highs, which again confirm the positive long-term trend for stocks as it has since 2009. The weekly WMA of the A/D line is rising strongly with major support now much lower at line b.

The weekly OBV also made a new high after bouncing off its rising WMA in the middle of May. This therefore triggered an AOT buy signal. The daily OBV (not shown) also made new highs last week.

The McClellan oscillator (not shown) is well above the zero line but has not yet reached overbought levels.



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S&P 500
The daily chart of the Spyder Trust (SPY) shows that prices are now closer to the daily starc+ band as the resistance level in the $194 area was easily overcome. For June, the projected pivot resistance is at $197.29 with the quarterly pivot resistance at $199.02. The weekly starc+ band is at $197.90.

The long positions established near the April correction lows are working out quite well. There is minor support now in the $193-$193.50 area with the rising 20-day EMA at $191.25. The monthly pivot and first support is now at $190.50 with the projected monthly support at $188.19.

The daily ADX line has risen further after breaking its downtrend, line b, and moving above its WMA. It is still below 20 so not really at trending levels but the pattern is bullish especially when combined with the other technical readings.

The daily on-balance volume (OBV) held above its WMA during the early part of May before turning higher. It has now moved to significant new highs. The weekly OBV (not shown) made a new high with prices last week.

The daily S&P 500 A/D (not shown) also made another new high.

Dow Industrials
The SPDR Dow Industrials (DIA) surged to the upside last Thursday and Friday, closing just below the monthly projected pivot resistance at $169.36, while the weekly starc+ band has risen to $172.37.

The weekly relative performance has dropped to new lows last week, which has aborted its bottom formation.

The weekly OBV has been in a shallow uptrend after breaking through the resistance at line g. It is well above its rising WMA.

The daily Dow Industrials A/D line (not shown) was strong last week confirming the price action.

There is initial support at $167-$167.70 with the 20-day EMA at $166.38.

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The PowerShares QQQ Trust (QQQ) was able to move convincingly above the early March high at $91.15 last week with the daily starc+ band now at $93.34. The monthly projected pivot resistance is at $95.35 while the quarterly is at $95.29.

There is first support now at the $90-80-$91.50 area with the rising 20-day EMA at $90.12. The monthly pivot stands at $89.43.

The daily OBV shows a clear pattern of higher highs but is still barely below the March high. Its WMA is rising strongly.

The Nasdaq 100 A/D continues to act much stronger as it surged late last week, further confirming the break through the resistance at line d.

Russell 2000
The iShares Russell 2000 Index (IWM) finally came to life last week as it closed the week well above the quarterly pivot at $114.53. The rising 20-day EMA is at $112.46 while the monthly pivot is at $111.26 and the recent swing low is at $111.11. The major support, line e, is now in the $107.17 area

There is next strong chart resistance in the $118.48-$118.92 area.

The daily OBV has just moved above its prior high, which appears to be the start of a new uptrend.

Even more impressive is the Russell 2000 A/D, which has finally broken its pattern of lower highs, line g, as it was strong after testing its WMA.

NEXT PAGE: Sector Focus, Commodities, and Tom's Outlook


Sector Focus
The iShares Dow Jones Transportation (IYT) had another great week gaining another 1.5% and making a new all-time high for the second straight week. The monthly projected pivot resistance at $146.58 has been exceeded with the weekly starc+ band at $149.50.

It was one of the 4 of the Year's Best Sector ETFs featured in last Friday’s column along with the Select SPDR Utilities (XLU), Select SPDR Health Care (XLV), and Select SPDR Energy (XLE).

All of the ETFs on the table are well in positive territory except for the Select SPDR Consumer Discretionary (XLY), which is just up 0.1%. It is looking much better and it was a recent addition to the Charts in Play portfolio

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The Spyder Trust (SPY) is up over 5.8% for the year while the SPDR Dow Industrials (DIA) is up over 2%. The PowerShares QQQ Trust (QQQ) has almost caught up with the SPY as it is up 5.5%.

There were several 2% gainers for the week including the Select SPDR Industrials (XLI), Select SPDR Energy (XLE), and the Select SPDR Financials (XLF).

Bond Market
The 10-year T-note yield closed near the week’s high and well above the lows from the previous week. The iShares Barclay 20+ Year Treasury (TLT) has reversed after testing its monthly projected pivot resistance at $114.63 last week. The daily OBV has broken the support mentioned last time and it may be completing a top. I will look at this in detail during the week and may have new recommendations.

Crude Oil
The August crude oil closed pretty much unchanged last week. The weekly OBV is still positive and a move above the week’s high at $102.94 would be positive.

Precious Metals
Both the Market Vectors Gold Miners ETF (GDX) and the SPDR Gold Trust (GLD) are trying to stabilize but the weekly charts and technical studies are still clearly negative.

The Week Ahead
Our bullish stance during the last few choppy months is now paying off as our long positions in the Spyder Trust (SPY) and PowerShares QQQ Trust (QQQ), as well as the individual stocks, are doing quite well. Even the dollar cost averaging program that I recommended in January is showing nice gains.

In my review of the Charts in Play Portfolio last week, I raised some stops and took some profits on stocks that had not yet broken out. They have now broken out to the upside but that is OK as the multitude of economic reports and the ECB meeting dictated that I stick with my normal game plan.

The tough part for those not in the market or who now feel they are under invested will to be patient. Be sure you do not chase prices as there will be setbacks likely in the next week or so that should create some good buying opportunities.

There are several industry groups and specific stocks that are still close to the year’s lows, and I will be looking for new buy candidates.

If you did not initiate the dollar cost averaging strategy last Monday as suggested last time, I would wait until the S&P 500 closes down 1% or more from its high to make the first of five equal dollar investments. I would wait three weeks in between your purchases.

Don't forget to read Tom's latest Trading Lesson, Picking Stocks in Non-Trending Markets.

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