Finding an Edge in a Dull Stock Market

How to gain an edge:

A bear jumps out of a bush and starts chasing two hikers. They both start running for their lives, but then one of them stops to put on his running shoes. “What are you doing? You can’t outrun a bear!” says one hiker, the other one replies: “True, but I don’t have to outrun the bear; I only have to outrun you!”

What’s the point? The market is the composite opinion of all other investors. In essence, you beat ‘the market’ (aka the ‘bear’) by knowing more than your fellow investors (aka the other ‘hiker’). Knowledge is the edge.

I consistently follow dozes of different indicators, which fall into one of these four categories:

• Supply & demand (liquidity)
• Technical analysis
• Investor sentiment
• Seasonalities & cycles

When all or most indicators point in the same direction, there’s a good chance stocks will move in that very direction. I call this a high probability trade.

The last such signal occurred in December, when liquidity, sentiment, technicals and seasonality pointed higher. The bullish weight of evidence, at that time, was discussed in this article: Is the Bear Market Over?

Since then, the S&P 500 has gained more than 20%. How much further can stocks rally?

Investor Sentiment

Some sentiment gauges show elevated optimism, but considering the strong Q1 2019 performance, overall sentiment is surprisingly subdued. Shown below is a selection of six different sentiment indicators. None of them shows an extreme reading. Without extremes, sentiment doesn’t provide an edge. It is possible for stocks to move higher.

Technical analysis

Short-term: The S&P 500 is nearing over-bought and is facing mild resistance. The chart below highlights trend line resistance and horizontal volume resitance (volume by price not date) for the S&P 500 futures. Now doesn’t appear to be the time to chase price.

Longer-term: The trend is your friend, but the risk of being ‘un-friended’ exists, and it’s difficult to find low-risk entries in an market that’s driven by momentum, but on the edge of being over-extended.

Elliott Wave Theory, the most exotic tool in the technical analysis tool box, is up to interpretation and of little help (more details here).

Supply & demand

Liquidity continues to flow into US stocks. Uncertainty in the European Union and money on the sidelines in the US are a likely cause for the continued inflows. My favorite liquidity indicator suggested throughout 2016, 2017, and 2018 that new all-time highs will be reached, and that message continues to be the same.

Seasonality & cycles

Bullish mid-term election year seasonal forces, discussed here, appeared late, but they did show up.

Based on mid-term seasonality, more gains are likely, but general S&P 500 seasonality is entering a higher risk window.

Cycles are conflicting.

Summary

There are times when most indicators point in the same direction (as in December), making a directional forecast easy.

And there are also times when indicators are in conflict, such as now.

That doesn’t mean we are left entirely clueless. Based on the market’s pattern in early March, we expected the S&P 500 to see-saw across obvious resistance at 2,815 and secondary resistance at 2,830. The S&P spent two weeks doing just that. But in order to unlock lower targets, it would have had to break below 2,785, which it didn’t.

Periods of relative uncertainty are always frustrating, but two things should be kept in mind:

1. It’s good to know when visibility is limited and act accordingly. Would you trust on Uber driver who’s speeding in the fog? Can you trust an analysts who’s ignorant of ,or over confident in periods of uncertainty? Knowing there is no edge, is an edge in itself.
2. Periods of uncertainty always end!

And when certainty returns, the Profit Radar Report will be there.