Market Report: how much further can this rally extend

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Last week’s market volatility was followed by a sharp reversal higher. While various speculative concerns remain (record valuations, frothy sentiment etc), the stock market’s uptrend remains intact for now.

 

Momentum

The stock market remains firmly in an uptrend. Momentum clearly favors bulls with the Russell 2000 having rallied more than 7.7% this week:

Historically, such large gains for small caps consistently led to more gains over the next 9 months. The one exception was in June 2000 as the dot-com bubble ended:

Momentum + breadth

Breadth and momentum are often linked (strong momentum = decent breadth). A consistently high % of S&P 500 stocks remain above their 200 day moving average:

Historically, such long streaks of solid breadth led to more gains for the S&P 500. Of particular note is the March 2011 case when stocks rallied for a few more months before a massive correction began:

Small caps outperformance

As I noted on Tuesday, small caps outperformed large caps for 5 months in a row:

Historically, this often led to more small caps outperformance over the next 6 months:

Volatility

As I noted on Thursday, VIX is falling quickly after a sharp spike.

When VIX fell more than -30% over a 3 day historical period, the S&P 500 was almost always higher 6-12 months later, although this could first lead to more short term volatility in the stock market:

Sentiment & Insider selling in 2 sectors

I highlighted various risk factors in recent weeks, such as an explosion in IPOs, options speculation, a surge in margin debt, elevated Gamma Exposure & SKEW, etc.

Several of these risk factors decreased with last week’s pullback. But one of the most egregious factors remains the lack of corporate insider buying. This week I want to highlight corporate insider transactions in 2 particular sectors: healthcare and financials.

The healthcare sector’s Insider Buy/Sell ratio has plunged to the lowest level in a decade:

Similarly, the Financials corporate insider buy/sell ratio fell to new lows:

While corporate insiders are selling stocks, investors are piling into S&P 500 ETFS (according to Bloomberg):

Meanwhile, my Medium Term Sentiment indicator remains elevated due to the lack of a solid stock market correction:

While frothy sentiment may be a short term concern, consistently elevated sentiment is a bullish factor for stocks over the next year (similar to momentum).

Conclusion: market outlook

Here’s how I approach markets based on 2 different strategies & time frames.

  1. Short term trend followers should continue to ride the rally because no one knows exactly when it will end. If you are a short term trend follower, you must use stops.
  2. Medium term contrarian traders should go neither long nor short. Risk:reward doesn’t favor long positions right now, while shorting into a speculative rally can end in disaster.

Click here to see the Insider Trading Model that I use.

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