· Longer-term technical indicators on equities continue to look very strong.
· Overall market sentiment could be a nice contrarian reason to remain bullish.
We take a closer look at market technicals and sentiment this week with the historically volatile second half of October upon us. Although there has been some near-term volatility and equity weakness, the longer-term technicals on equities continue to look very strong. We will show this by examining three different technical indicators that, combined, show the potential for positive longer-term signals for equities. Turning to overall market sentiment, the overwhelming evidence suggests there is still a significant amount of worry about future price returns. From money leaving equity funds, to market sentiment polls showing an unusually high level of worry this close to all-time highs, sentiment could potentially be a nice contrarian reason to remain bullish.
Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs.
Bullish Longer-Term Technicals
Best practices in technical analysis recommend looking for confirmation from multiple technical perspectives. The ability to have multiple technical analysis indicators confirm each other helps raise the probability of success in assessing future market direction. We have outlined three longer-term technical indicators below which together increase the level of confidence that equities move higher over the next 6 to 12 months.
Relative ratios remain bullish. The following relative strength ratios, based on historical data, can be used to gauge the probability of success in forecasting the potential future direction of the stock market [Figure 1].
· Stocks versus bonds. The stocks-versus-bonds ratio is helpful in assessing trends in the overall stock market. A rule of thumb is that when stocks outperform bonds it generally depicts a bullish trend for stocks.
Looking at historical data going back to 2004, when the weekly reading on the S&P 500 Index / Barclays Capital U.S. Aggregate Bond Index relative strength line chart is sustained above its 40-week simple moving average (SMA) for three trading weeks, subsequent long term price levels on the S&P 500 index tended to rise. Since 2004, this type of moving average crossover happened only 8 times. Six months later, the S&P 500 was higher 6 of 8 times (75%), with average total returns of 5.7%. Going out nine months, the returns are higher 8 of 8 times (100%), with average total returns of 9.2%. Looking out one year, the returns were higher 7 of 8 times (88%), with average total returns of 7.0%.