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August 10, 2020

Stock Market: overpriced by any historical standard

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The S&P 500 price index broke out of its June-July trading range last week and now has recovered nearly all of its 35% February-March loss.

The $SPX high at 3,393.52 on 2/19/2020 may be a critical resistance pivot point on the upside, while the low at 2,965.66 on 6/15/2020 may be a critical support pivot point on the downside.

Trend-following algorithms buy more stocks as stocks go up in price. This can be tricky. It works for a while, until suddenly without any warning it doesn't.

Momentum oscillators, such as RSI and MACD, both currently show modestly rising momentum for the short term. Both remain below their June peaks, however. Therefore, momentum is diverging bearishly from price, which is above its June high.

The percentage of the S&P 500 stocks above their 50-day SMA also turned up modestly last week, but it remains below its own trailing 50-day SMA. It has been neutral most of the time over the past 6 weeks. This breadth momentum indicator has been lagging price, and it continues to diverge bearishly from price.

$WLSH, the Wilshire 5000 Composite, includes all of the stocks in the S&P 500 Composite plus 4500 additional stocks. It is the broadest and most inclusive capitalization-weighted index, so it may offer a worthy, big-picture perspective on the position of the main stock market trend. The weekly chart shows that in January, 2020, as price rose to higher highs, RSI price momentum signaled a bearish divergence, making a lower high compared to its 2018 peak. And although $WLSH price has recovered nearly back to its highs of 2020, RSI remains well below its high of 2020, thereby diverging bearishly from price. In March, 2020, RSI fell below 30, and the two previous times that happened, the stock market was in a major bearish trend with further to go on the downside. Although past precedents are essential for rational analysis, there is no guarantee that history will repeat.

The NASDAQ Composite Index rose to a new high last Thursday. Momentum oscillators, such as RSI and MACD, did not make new highs and remain weaker than price, indicating bearish momentum divergence.

The cumulative daily net volume of advancing issues minus the volume of declining issues on the NYSE turned upward last week but remains well below previous highs. Therefore, it remains weaker than the price indexes, indicating bearish volume divergence.

The cumulative daily net number of all advancing issues minus the number of all declining issues on the NYSE rose to a new high last week, indicating a bullish breadth divergence compared to the S&P 500 price index. Listed issues that are not common stocks have been carrying this data higher.

The cumulative daily net number of advancing stocks minus the number of declining stocks on the NYSE for common stocks only offers a different perspective on breadth. It failed to rise to a new high to confirm the all-issues A-D Line (charted above), so it is still indicating a bearish divergence compared to the all-issues A-D Line.

The number of daily net new highs on the NYSE remains modestly positive.

The Dow Jones Transportation Average moved above its June high but the Dow Jones Industrial Average remained below its June high and failed to confirm a rising trend. This suggests that key segments of the stock market may not be pulling together at this time. Such non-confirmations often appear at trend change junctures.

Fundamentally, the US economy contracted at a 32.9% annual rate from April through June, 2020, its worst drop on record, the Bureau of Economic Analysis announced on Thursday 7/20/2020. Jerome H. Powell, the 16th Chair of the Federal Reserve, told the House Financial Services Committee on 6/30/2020, "Output and employment remain far below their pre-pandemic levels. The path forward for the economy is extraordinarily uncertain and will depend in large part on our success in containing the virus. A full recovery is unlikely until people are confident that it is safe to reengage in a broad range of activities."

The Fed and all the major central banks have been aggressively providing liquidity to the global financial system in an extraordinary effort to stem economic collapse. The U.S. Federal Reserve increased its Total Assets by 84% over the past year. On 7/29/2020, Fed Chair Powell said, "High frequency data appears to be softening since mid-June.... We are committed to using our full range of tools to support our economy in this challenging environment.... We have the ability to do more." The central banks' massive flood of new liquidity has been an important driver behind the stock market recovery since the March low.

Seasonal tendencies based on past market history can be somewhat useful but are not as powerful as momentum and trend indicators. The second week of August has shown mixed to slightly bearish tendencies.

We are well aware of the hopes that have been driving stock prices: hope for further Fed monetary policy accommodation, hope for further government fiscal stimulus, hope for a Covid-19 vaccine to make it go away, hope that the depressed economy can soon return to normal with a big economic rebound. Hope is not a viable investment strategy, however. Available actual facts do not support high hopes. We choose to focus on actual facts.

Our first priority is to protect and preserve your capital. We always carefully weigh potential rewards against potential risks when we consider any investment. This is not as simple as it may seem. When we analyze all the facts and details, the objective evidence is often mixed, with both positives and negatives, and often neither significantly outweighs the other. If the potential rewards do not significantly outweigh the potential risks, we reject that investment. Markets can be volatile, indeed extremely volatile at times, and long experience has taught us that it is better to be cautious in times of uncertainty than it is to take unwarranted risks that could result in substantial losses which could make recovery extremely difficult. At this time, we must agree with Fed Chairman Powell: the outlook is extraordinarily uncertain. That warrants caution.

We moved out of the stock market in January, weeks before the March crash. That was a smart move, because the S&P 500 collapsed 35%. Based on actual facts in the context of the actual history of the stock market, we did not foresee the rapid stock price recovery since the low on 3/23/2020, which has recovered nearly all of that 35% loss. Market history suggested that it would be most unusual for a new bull market to start so soon after the severe damages sustained in March. History is not an infallible guide, however, and now speculation, hope, and irrational exuberance have driven stock prices to levels not justified by fundamental and technical analysis. Now, stock prices are overpriced by any historical standard, and that means that the stock market is at risk.

Investor sentiment has been trending toward overbought greed, with the sole exception being an unexplainably high percentage of AAII BEARS. Sentiment became excessively bearish in March, resulting in an extreme oversold condition that led to the recent oversold short-covering recovery. Now, that extreme oversold condition has mostly dissipated. Sentiment is a supplemental indicator that is less important than trend and momentum. It is a contrary indicator that is sometimes useful for counter-trend trading. Markets are complex adaptive systems that reflect the emotions of the crowd reacting to contradictory and incomplete information as well as changing decision rules. Prices tend to swing to emotional extremes of optimism and pessimism. When there is a great majority of bulls, few investors are left to buy, and rallies suddenly can fizzle and reverse. Conversely, when there is a majority of bears, few investors are left to sell, and short-squeeze rallies suddenly can appear seemingly out of nowhere--the bounce after the March 23rd low is a good example. Neutral and mixed sentiment tends to coincide with uncertain, indecisive markets.

$VIX, Volatility Index broke down below its June low and its 50-week SMA, suggesting diminishment of the stubborn skepticism about the rise in stock market price indexes since March and a trend toward bullish complacency.

!NAAIM, The National Association of Active Investment Managers long-side exposure to US equity markets remains near its highest level of year 2020. It is extremely overbought.

!AAIIBEAR, the percentage of individual investors that are bearish remains well above-average, indicating stubbornly oversold sentiment. This indicator is an outlier, contradicting the others.

!PCRATEQU, the Equity Put/Call Ratio has been below-average most of the time since mid April. As of 6/8/2020, it had fallen to 37, which was one of the 12 lowest levels in 19 years. It could take time to work off that extreme level of overbought.

The CNN Money Fear & Greed Index indicates Greed (overbought). See

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Analysis of market forces may offer a sense of probabilities. But the many variables that can impact market prices are notoriously difficult to predict. And, market analysis is something less than an exact science. So, sound trading tactics are always recommended. See my
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Robert W. Colby, CMT,
is a consultant to institutional and private investors and traders, providing regular analytical reports, custom research services, and trading systems tailored to clients' objectives. Clients include the most successful traders and investors in the world. Robert is the author of The Encyclopedia of Technical Market Indicators, Second Edition, McGraw-Hill, 2003, which has become the standard reference for indicator and trading systems design. Previously, at several large Wall Street firms, Robert worked as a proprietary trader, technical analyst, and fundamental analyst. He also was adjunct professor at New York University and New York Institute of Finance, where he developed new courses on technical analysis and market timing.

Robert W. Colby is a Chartered Market Technician (CMT), an accreditation granted to members by the CMT Association ( after demonstrating professional competence and ethics over a period of many years. Robert has been a member since 1980, and he strongly supports the CMT Association's high standards. He also supports the The Technical Analysis Educational Foundation (, which works to have technical analysis included in the curriculum of major business schools. The CMT Association is the national organization of investment analysts, stock market analysis professionals, and certified market technicians in the United States.

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Active Trader magazine September 2004 interviewed Robert W. Colby. 4 pages. "Robert W. Colby: Technical collector. A discussion with Robert W. Colby about technical trading and his revised Encyclopedia of Technical Market Indicators, Second Edition. By Active Trader Staff."
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MetaStock® PC Software for Technical Analysis
MetaStock® is a powerful technical analysis software program for your personal computer. It offers more than 200 built-in indicators and line studies to enable you to explore a wide variety of methods. And it empowers you to build, back test, and optimize custom trading systems to suit your own particular requirements.
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