VRA UPDATE: BULLS PLAYING WITH FIRE

VRA Update (Aug 18, 2015)

At the risk of sounding “emotional” (because emotions and money have no business even being in the same room together), this continues to feel like a market that wants to go lower. It also feels like volatility is about to begin a slow boil…

As I said in yesterday’s communiqué, a brewing storm looks to be on the horizon. At this point, the VRA Trading & Investing System is indicating that the coming pullback and volatility will be just that…a pullback…but once these things get underway, the downside pressure could “absolutely” take over.

Before I get into more specifics, please take a few minutes to read the following from Market Watch news and Mark Hulbert Research, which is the most accurate “sentiment” research on the planet…as you can see, it has become decidedly bearish. As you read this, you’ll recognize many of the points being made, as Hulbert’s research makes clear exactly what I have been reporting over the last week or so…namely, that the stock markets internal readings and its “new highs/new lows” are anything but healthy.

STOCK MARKET BULLS PLAYING WITH FIRE

(MarketWatch) -- Investors who are giving the bull market in stocks the benefit of the doubt are playing with fire. That's because the bear market's warning signals have created a situation as vulnerable to the slightest spark as a parched desert.

The latest warning comes from the so-called High-Low Logic Index. That well-regarded indicator was created by Norman Fosback in 1979, then the president of the Institute for Econometric Research, and currently editor of Fosback's Fund Forecaster. The index represents the lesser of two numbers from the New York Stock Exchange: new 52-week highs and new 52-week lows (both expressed as a percentage of total issues traded).

The indicator, therefore, is a measure of internal market divergences. In his investment textbook "Stock Market Logic," Fosback reasoned: "Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows -- but not both. ... A healthy market requires some semblance of internal uniformity." 

By this measure, the current stock market is anything but healthy. The 10-week moving average of weekly readings recently rose to 5.7%, well above the level that many researchers use as the threshold for a "sell" signal. (Fosback, for example, set this threshold at 5%, considering readings above that level as evidence of "extreme market divergence and ... bearish." The threshold employed by Ned Davis Research, the Venice, Florida-based research firm, is 4.4%.)

Why hasn't this dangerously lofty level of the High Low Logic Index received more attention? There are at least two reasons.

The first: The index has a better track record over longer, rather than shorter, spans, and its signals can be premature. Prior to the 2007-2009 bear market, for example, which began in October, the High Low Logic Index breached the 5 threshold in late July. So it's possible that some of the bulls are worried about the High Low Logic Index but are waiting for confirmation from other indicators before pulling some of their chips off the table.

The other reason that some are ignoring these latest warnings is that the index gave a number of false signals in 2013. As you can see from the accompanying chart, in fact, it rose to near 6 in the summer of 2013. (I wrote a column reporting its dangerously high level in August of that year (http://www.marketwatch.com/story/dangerous-divergences-unseen-since-2007-2013-08-21).) Needless to say, the bull market didn't soon come to an end. 

You'll also notice from the chart that the High Low Logic Index rose to an even higher level at the end of last year -- hitting 6.9 in late December. It's too early to know whether that, too, will prove to be a false signal, though I would note that the Dow Jones Industrial Average is lower today than it was then. 

One adviser who is particularly worried about the message of the High Low Logic Index is Doug Ramsey, CEO of The Leuthold Group. He points out that, unlike the situation that prevailed on the occasion of those false signals a couple of years ago, this time around there also is extreme divergence in the Nasdaq market, in particular.

In fact, Ramsey reports that a Nasdaq-only version of the High Low Logic Index just rose above its "sell" threshold for the first time since 2007. I need not remind you what happened at that time.

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China – Still a Worry and WALMART Disappoints

As you can see, this indicator is incredibly respected, although it’s timing may not always be spot on. In this case, the news from overnight and this morning might help to speed up the selling pressure. 

China’s markets were hit hard overnight once again, with losses on both the Shanghai and Shenzen over 6-7%. It’s clear that the downside pressure in China is not over…this is bad news for global markets and for the rest of the world’s economic growth.

Then, just minutes ago, Walmart reported earnings and they were less than comforting, with revenues missing by more than $1 billion and EPS off by 2-3% from expectations. Folks, Walmart RARELY misses their estimates…that’s because they know how to play the “sell-side analysts quarterly earnings game” and they spoon feed pretty much the exact forecasts that they want the analysts to report.

Here’s why this is a bigger deal than is being reported; for Wally World to miss, this tells me that the final 2-4 weeks of the quarter was VERY weak…doesn’t bode well for the coming 3rd quarter, and quite possibly, even the 4th. Walmart’s down 3% as I type... 

However, at the same time, we just got earnings from Home Depot and they were VERY positive…HD’s shares are up 1.7% as I type. And housing starts are coming back for certain. However, is this just an end of cycle move higher??

It’s exactly this kind of domestic economic uncertainty that has investors spooked.

GOLD, THE MINERS AND NUGT

You know my thinking here…the miners have hit bottom and should be bought…of course, I feel the same way about gold/silver as well.

In fact, we have some pretty good company in the gold bull camp. Investing heavyweight Stanley Druckenmiller just bought more than $300 million worth of our favorite yellow metal and it now makes up more than 20% of his entire portfolio. He joins a list of smart money investors plowing into gold that is growing faster than we can keep track. 

THIS FED RUMOR MAY BE THE ONE THING TO WATCH

I’ll have more on this later….I’m running down all of my top experts on this now…but the latest rumor to hit is that the FED will NOT raise rates in September, and that it will be December at the soonest. Should the FED announce this, we can expect a rather decent “relief rally”.

Finally (for now), the longer the Dow, Russell 2000 and Transports stays under their 200 day moving average, the more negative we should become on the overall market. We’re at close to 3 weeks on the Dow, and along with the other concerns I have laid out here, this ones a biggie. This is not how bull markets act…

I fully expect volatility to return as we move forward…especially in the always interesting September/October “crash friendly” months.

Until next time, thanks again for reading….

Kip

Vraletter.com