When it comes to investing, it is difficult to accurately predict the future. Most of the technical tools used by investment analysts are considered trailing indicators. In other words, they try to forecast what will happen by looking at what has already occurred. Sometimes that works well. Other times, the outcome is unexpected.

Most technical and fundamental analysis focuses on the price and movement of an investment. Things like price and volatility are known, measurable quantities. As a result, there is data that can be studied and dissected.

Many—if not most—investors, however, are emotional rather than analytical. They make investment decisions based on how they feel. As a result, it can be difficult to predict what they are likely to do.

More than 60 years ago, economists at the University of Michigan created a tool called the “consumer sentiment index” that tries to measure intangible investor emotions. They came up with a series of questions and once a month there is a random telephone survey of at least 500 people across the United States. In 1964, the index was normalized to have a value of 100.

The May consumer sentiment rose to 83.7 from 76.4 in April. It was the highest reading since July 2007. Economists were anticipating a May reading of 78. The increase in the index means that consumers are feeling better about the economy. That means they are likely to spend more money.

Unlike most technical tools, the Thomson Reuters/University of Michigan Consumer Sentiment Index is considered a leading economic indicator. The rising index is positive for the stock market. It means that the market gains seen since November are likely to continue.

The chart below shows how major indices fared over the past month. The Nasdaq is currently leading the group with a gain of almost 9% in the past four weeks. Even the Dow has gained almost 5% in that same period and many major indices are at all-time highs or at least at multi-year highs.

As we have noted for several weeks, technical indicators are all strongly positive for stocks. This news about the unexpected jump in consumer confidence should be welcomed by investors who are worrying that the current advance is getting overextended.

Flint Stephens

This week the Dow and the S&P 500 solidified and add to the new all-time highs they reached a week ago. As stocks continue to climb, more experts are talking about a market bubble and the prospects for a significant correction.

It is difficult to argue against an eventual major downturn. After all, it is the nature of the market to have both bull and bear cycles. But the technical indicators I watch are not yet showing any indication that this strong advance is in imminent danger.

Below is a chart showing performance of the S&P 500 over the past two years. On the top portion of the chart I’ve added two simple moving averages: the blue line is a 200-day moving average (MA) and the gold line is a 50-day MA.

The 200-day MA is a good indicator for long-term trends. The S&P 500 crossed strongly above its 200-day MA in early 2012 and has been trending above that mark ever since. Right now, you can see that the gap between the blue line and the current price is very wide. That could be viewed as a sign that the index is overbought and due for some consolidation or correction. But it is also a testament to the strength of this bull market.

The 50-day MA is better to gauge intermediate trends. Over the past seven months, the S&P has held above the gold line. Over the past 16 months, there have been only two periods when the S&P fell below its 50-day MA for a few weeks.

The next section of the chart is a moving average convergence divergence (MACD). The MACD bottomed most recently in November 2012 and it has trended above zero since the following month. Once again, the current level of this indicator could be viewed as being overextended on the positive side. During strong bull trends, however, this indicator can remain in such a state for several months as we have seen since the start of this year.

The next section of the chart is a relative strength index (RSI). When this indicator trends above 50, that means the S&P 500 has strength to sustain an upward trend. When it approaches 80 that is a signal that things are overextended and a consolidation will almost immediately occur. This indicator is not signaling an imminent downturn. In fact, it could continue to hold near its current levels for many weeks.

Finally, the bottom section of this chart is a stochastic oscillator. This tool is near its highest level, which signals that the S&P 500 is overbought and will likely consolidate for a few sessions. This is a common pattern during a powerful bull market and you can see that it has been in the upper range quite a bit during this advance.

The consensus of these indicators is that the S&P 500 Index is currently overextended. From these levels it would be natural to expect some consolidation. But there is no indication now that a major trend reversal is on the horizon.

In April the index corrected slightly and briefly touched its 50-day MA. But it bounced back from that level and climbed to a new all-time high just four weeks later.

I have a good friend who is an investment advisor and he believes that a major correction will begin in June. He could turn out to be correct. But years of market watching have taught me that no one can reliably forecast major market turning points several weeks prior to their occurrence.

In 1997, many market analysts believed that the technology sector was overvalued. Some experts were forecasting a major downturn in tech stocks. They turned out to be right, but even thought the Nasdaq was overvalued in 1997, it continued to climb in 1998 and 1999 before the major correction occurred.

The next bear market could begin in June, September, or November. It might not start until sometime in 2014 or 2015. It will surely happen at some point and when it does, it is likely to be painful and even financially devastating for those who get caught unawares.

We believe we have very good indicators that will provide us with some warning before that next bear market arrives. We also practice an active diversification strategy that should protect our positions even if we are wrong about the timing of the next major market collapse.

For now, though, our indicators are forecasting blue skies and clear sailing for the foreseeable future..

Flint Stephens

For the first time in history, the Dow climbed above 15,000 on Friday and the S&P 500 rose above 1,600.I was brand new to the financial industry when the Dow first reached 3,000 in 1991. It was pre-Internet and before the days of television channels devoted exclusively to market news. In those days, many people relied on financial newsletters to help them decipher market moves.

I was working for Howard Ruff. Howard was a best-selling author and he produced a weekly investment newsletter with nearly 300,000 subscribers. He also published several other investment newsletters. I was one of several editors and writers working on multiple publications.

We had a stock ticker in the office and when the Dow crossed the 3,000 barrier that day, everyone in the office cheered and clapped. Everyone considered it a significant milestone—partly because most remembered four years prior when the Dow suffered its worst ever one-day loss of more than 21% on October 19, 1987. In August of that year, the Dow eclipsed 2,700 and it seemed likely that it could break 3,000 before the end of 1987.

After reaching 3,000 in 1991, it took less than four years before the Dow crossed 4,000 in 1995. It also broke 5,000 that same year and 6,000 the next year in 1996. On the chart below, you can see the Dow’s acceleration during that period. The 1990s were unlike any period the market experienced before or since.

This 15,000 mark is significant because the Dow crossed above 14,000 in 2007. It has taken six years for the Dow to cross this latest milestone. From a technical perspective, crossing these kinds of psychological barriers is not especially significant.

As major indices persist in this bull market that began in 2009, more analysts are expressing concern that stocks are overvalued and overdue for a correction. Unfortunately, it is impossible to accurately predict exactly when that downturn will occur.

As we witnessed in the 1990s, just because stocks are overvalued does not necessarily mean they cannot continue to climb higher. One unchanging investment truth is that bull markets will be followed by bear markets. Even though we don’t know when the next bear market will start, we will trust in our indicators to give us advance warning.

In the meantime, we should celebrate this most recent milestone and the continued advance.

Flint Stephens

Everyone knows that so far, 2013 has been a great year for investments. Of course, the financial markets are multifaceted. In other words, just because certain stocks have performed well does not necessarily mean all stocks have performed well.

In fact, many investors might be surprised at how some diverse market segments have performed over the past three months. The chart below offers a visual representation of some of those sectors.

The black line is the S&P 500. This blue chip index has been a leader in 2013 and it advanced about 5% during the past 90 days. For that period, it is slightly trailing real estate stocks, which are shown on the chart with a red line. IYR is an exchange-traded fund (ETF) that tracks the Dow Jones Real Estate Index.

Interestingly, over this three-month period long-term U.S. Treasury bonds (TLT) are performing about the same as the S&P 500. Usually bonds are considered to have an inverse relationship to stocks. Obviously that has not been the case recently.

When the U.S. market is doing well, international stocks usually advance as well. Often they will outperform their U.S. counterparts in bull markets. Over the past quarter, however, the U.S. market has provided leadership. EFA is an ETF that tracks MSCI EAFE Index that includes stocks from Europe, Australasia and the Far East (22 countries). Shown as a blue line on the chart, it is up about 4% over the period depicted.

The two laggards on this chart are gold (GLD) and oil (USO). Gold has a double-digit loss for the period and has maintained a downward slide since fall of 2012. Oil has also struggled and is about 25% lower than it was at this same time last year.

Last week we wrote that the coming days would prove to be important in showing whether the recent market advance would continue or whether increasing volatility and risk were indicators of a coming correction.

This week stocks rebounded strongly and major indices climbed back near the highs they set earlier in April. With just two trading days left, it is likely April will end up as another month with solid gains.

There is an old market adage that says “sell in May and stay away.” For the past four years, stocks have faltered in May and into the summer months. As the financial industry is fond of reminding investors, past performance is no guarantee of future results.

At this moment, the rally that began in November 2012 shows no signs of ending. But we will keep a close watch on our technical indicators just in case.
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Flint Stephens

So far in 2013 major stock indices have advanced strongly with little opposition. That all changed this week as stocks had their worst week so far in 2013. To keep things in perspective, this retreat so far amounts to about a 3% drop on the S&P 500 Index. Still, many investors are worried because of the volatility associated with this move.

Although the increase in volatility means that risk is heightened, there is no reason for investors to panic. A review of technical indicators shows that the end of this correction could be at hand.

Below is a performance chart of the S&P 500 over the past year. When comparing the current decline, we see that it is much less severe than retracements that occurred in October and May of 2012. While those downturns were painful, they were fairly typical bull market corrections that did not threaten the long-term advance that began in 2009.

The gold line on the chart is a 50-day moving average (MA). This is a fairly simple indicator that helps measure market strength and risk. In the two 2012 downturns mentioned above, major indices dropped well below their moving averages. In our current situation, the S&P 500 is resting right at its 50-day MA. If it were to drop significantly below that mark, that would be the first indication that investors might need to pay closer attention to increased risk.

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The next section of the chart is a moving average convergence divergence (MACD) indicator. It crossed over and turned downward recently, but it remains at a positive level well above the zero level.

Immediately below the MACD is a relative strength index (RSI). This indicator provides a measurement of the S&P 500’s strength and momentum. When the RSI is trending above 50 that means the S&P can sustain a rally. This week the RSI dipped below that 50 mark. If it continues to remain below 50, that would be an indication of rising risk.

The bottom section of this chart might be the most significant in the current situation. This portion is a stochastic oscillator. It measures market cycles. It is currently at about 20. Under normal circumstances, when this indicator falls to or below 20, that means selling pressure is exhausted and a new upturn is likely to occur.

With increased volatility and multiple indicators right on the border between negative and positive momentum, this is obviously an important juncture for stocks. What happened next week is likely to tell us whether the uptrend remains intact or whether we need to take action to protect against growing risk.

Flint Stephens