Both Bulls And Bears Leave Evidence To Make Their Case

As Published on MarketWatch Trading Deck August 19, 2016

There are a million ways to look at the stock market. It needs to be investigated in an unbiased fashion with no opinions or preconceived notions as to the outcome. So, what I want to do today is share as much meaningful evidence as possible for both the bull and bear cases, and then end with a verdict.

Let’s start with the bull case:

• After roughly 14 months, the market was finally able to break out to new all-time highs.
• The longer-term 200-day moving average is sloping upward
• Since the Brexit lows, the evidence exhibited by volume, buying and selling pressure shows very little increased selling that would normally be present in the case of an imminent correction or market crash.
• Since hitting new all-time highs, the S&P 500 has yet to move to an oversold, exhaustive state when looking at the evidence exhibited by momentum — as referenced by relative strength (RSI)-5, RSI-14, and the moving average convergence/divergence (MACD).
• Finally, a trend is up until it’s not – and until the market breaks back below the previous, all-time high annotated in the chart below, the trend is up for now.

Now the bears’ case:

• For starters, statistically and historically speaking, May through October are the “seasonally weak” months of the year for the market. If you were invested only in these “weak” months since 1950, you would’ve actually lost money after 65 years of investing experience.
• The third quarter of the year is the worst quarter, on average, for market performance.
• As you can see in the chart below, while the market has broken out to new highs, momentum as illustrated by MACD is showing evidence of slowing down since the end of July.
• RSI-5 in the chart below gives us a good look at short-term momentum, and since the breakout in July, the market has become consistently overbought with no significant “breather,” which increases the probability of a near-term pullback.
• While we’ve seen reduced selling since the Brexit lows (which is bullish), the evidence also shows that the recent market highs have been met with very little buying enthusiasm as the market has risen (shown in blue arrows below). So while sellers have taken a vacation, buyers haven’t replaced them.

The verdict

Short term, the largest amount of evidence points to a market pullback sometime in the next month or two. In fact, it’s entirely possible we could be in the midst of the pullback as you read this column.

Intermediate term, however, the market is telling us that there might be additional strength over the next three to six months after such a pullback occurs. This would give investors an opportunity to buy the dip and clip off a little more growth before we move into the post-election year, which just happens to be the worst year for the stock market, on average, of the four-year election cycle.

With all that said, the S&P500 is only up 8.10% since the last stimulus package ended on October 31, 2014, and it’s only up roughly 2.50% since breaking the May 2015 highs. When you hear about “new all-time highs,” it’s important to put things in such context as opposed to running out to buy every stock in sight.

While the market might limp to some additional gains this year, it’s also crucial to exhibit patience. I’m not a big baseball fan, but in baseball, if you have a strike called against you, it’s still a strike, whether you agree with the umpire or not. It’s also still a strike if you didn’t think the risk was worth swinging the bat on a particular try, but the ball sinks through the strike zone anyway.

Like baseball, investing takes time, concentration and patience. Where they differ, however, is in the fact that investing, you can stand around all day and wait for the perfect pitch. So my advice? Wait for the pitch. Don’t swing at anything and everything. Desperation + investing = striking out.