3 Signs of a Tired Market

02/27/2012 8:30 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

MoneyShow's Senior Markets Editor Jim Jubak reviews the three indicators that suggest to him that we may be closer to a significant market correction.

It’s pretty clear we’re in an overbought market. That’s a market where valuations are starting to get stretched and sentiment is starting to get either complacent or really too bullish.

Usually what happens then is you get some kind of correction—not necessarily a huge plunge. You get a correction of maybe 5%, 8%, 10% that resets the market, and you build a new base and you start again from there. At least that’s the ideal scenario.

The problem with dealing with an overbought market is you really don’t want to buy at the top, but an overbought market can be overbought for a long period of time, so you try to look at indicators to see how close you’re getting to a top. What’s really more important than looking at any individual indicator is looking at how many indicators are all showing the same thing.

In a post not so long ago, I talked about an indicator from Investors Intelligence called Advisors Sentiment that sort of tracks bullish-bearish sentiment among advisors for people who manage money. What it showed is that we were at 54.8% bullish.

That’s a high percentage of bullish. It’s not at the peak, which was 57.3%, so 54.8% to 57.3%—57.3% was where we were in April 2011, when the market peaked, so we are approaching it,. but we haven’t quite gotten there. On the basis of that one indicator, you could say, "OK, I am concerned."

The other things that I am watching right now are rallies. Certain sectors lead the way. You look for leadership from technology and financials, and consumer discretionary goods, because these are the kinds of companies that show really good earnings when a market is going up, and people buy them because they are growth stocks and people have optimism about the future.

What’s interesting right now is that with the exception of technology, pretty much all these have started to lag. They started to lag really in the first two weeks of February...so again, not a big problem by itself,. but it’s not a good sign that leadership is starting to falter from some key sectors.

The last thing that I have noticed recently is that small-cap stocks, which tend to lead rallies—and certainly have led this one; the Russell just killed the S&P in 2012—they have started to falter too. They are not going down, but basically since around February 3, they have flattened.

So we look at all these things, and it looks like the level of enthusiasm about this market is flagging. That’s exactly what you expect as you start to put in some kind of top in an overbought market.

So these are the things I'm watching right now. I am not headed for the sidelines. I am not panicking. I am trying to raise a little cash.

I am trying to take down some of the risk in my portfolio because I think we are looking at a correction in sometime not too distant future. What I am looking for is a pullback, not a crash, not a plunge, but something that resets the market.

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