T2108 Update – July 7, 2011

(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. To learn more about it, see my T2108 Resource Page.)

T2108 Status: 78% and overbought.
VIX Status: 16.
General (Short-term) Trading Call: Close “almost all” bullish trades (longs), accelerate bearish trades (shorts). Caveats noted below…

Commentary

T2108 hit 78% today for its highest close of 2011. The stock market had another strong sprint with the S&P 500 leaping 1% and once again trading well above the upper Bollinger Band. The S&P 500 is now 1.3% away from retesting the multi-year (intraday) high set on May 1. Apple (AAPL) has suddenly become a great proxy for bullish sentiment. The stock finished trading today up another 1.55% and is within a few points of its all-time high. The stock has soared in nearly a straight line since the June 20 bottom and broke its recent downtrend last week. As I mentioned before, it is hard to get overly bearish if Apple is soaring and a break into new all-time high territory would force me to throttle back on adding fresh shorts. This is a major caveat to the trading call to get more aggressive on shorts (but it does not change the trading call to sell off most trading longs).

Given the stock market is closing in on the May high, this is a great time to recall my study on the “sell in May” adage where I concluded:

“… it is not typical for the market to top out in May for the year. When May is not the high for the year, traders get all summer long for repeated chances to bail for the year.”

The May 2011 high is a multi-year high so the summer has a tall hurdle ahead. June was of course a complete failure in re-challenging those highs. Using the logic above, if July fails to break the May high, we could start to wonder whether May’s high will be the high for the year. Stay tuned on that one!

Also note my recent study on summer trading: “Summer’s Positive Gains Can Come With High Risks.” Today’s close put the summer into positive territory. However, just as I explained in that piece, these small gains come at significant risk. For example, to get the current 1% gain, you had to sit through a 6% drawdown in June – very poor risk/reward.

Given this confluence of data, short-term traders will find themselves at a very difficult juncture. The temptation to stick with the current trend will be very high. Yet, the risks for following this course are now rising fast and furiously. I will once again advocate sticking to rules and ignoring the news as much as is practical. For example, Doug Kass does a great job as always describing how the stock market is ignoring the strong economic and event risks in “The Bizarro Market.” If you had let the fundamentals scare you, you never would have followed the T2108 rules to buy into June’s oversold conditions. Similarly, there are happy bulls somewhere out there now boldly proclaiming that the market is cheerfully climbing the wall of worry and providing solid-sounding reasons to counter all of Kass’s concerns. Pinch yourself if you find the current rally increasing your willingness to listen to such happy talk.

Yes, navigating this juncture will NOT be easy!

One way to mitigate the risk of adding to shorts here is to wait until the S&P 500 finally shows some sign of real weakness – like a close below the low of the previous trading day. Such a close has yet to occur since the bounce from the 200DMA started in earnest on June 27. A more tentative trader may also choose to hold on to bullish trading positions even as s/he adds to short positions. I think this is the least preferred option since the next pullback will likely be sharp, come with little warning, and will likely scare anyone following such a scenario into acting too rashly and too quickly.

Weekly T2108

*All charts created using TeleChart:

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SSO puts, long DB puts