From Standard & Poor's Equity ResearchThe stock market appears to be running on all cylinders, and despite some fairly severe overbought readings, the rally probably has further to go. Bond yields reversed sharply to the downside last week while crude oil prices continued to base.
In our opinion, the stock market is acting like it has just entered a new bull market, with the four-year low occurring back in June and July. Often, the market drops much more than it did this year during the 4-year cycle low, with the peak to trough decline in the S&P 500 being only 7.7% and only 14.8% for the Nasdaq.
What often times define the beginnings of a bull market (following a bear market) are dramatic price gains, extreme overbought conditions, and a lag in market sentiment to the bullish camp. Following the major bear market in 1932, the Dow Jones Industrials soared 92% in 50 days and the peak 100-day rate-of-change (ROC) was 64%. In 1975, the peak 50-day ROC for the S&P 500 was 27% and the peak 100-day ROC was 30%.
Following the bear markets in 1982, 1990, 1998, and 2003, peak 50-day ROC for the S&P 500 was between 18% and 35%, and the peak 100-day ROC was between 23% and 33%. These returns were all after bear markets that occurred during the 4-year cycle lows except for the 1932 bottom.
Since it does not look like we are going to have a major 4-year cycle low or bear market this year, we can look at a couple of recent years that coincided with the 4-year low when the market did not have a bear market, and they were 1986 and 1994. During 1986 the S&P 500 fell 9.4% and bottomed at the end of September. Following this corrective low, the S&P 500's peak 50-day ROC almost got to 20% while the 100-day ROC topped out at 26%.
The S&P 500 fell 8.9% in 1994 and basically went sideways until hitting the final low in December. The S&P 500 then rose 9.3% on 50 days with the peak 100-day ROC being 17.6%. Of course, the market went into its historic run following the corrective low in 1994, and did not peak until 2000. The mini-bear market in 1998 was the only real interruption of this powerful advance into 2000.
So far, the peak 50-day ROC for the S&P 500, coming out of the low in July, was 8.7%, almost equaling the 9.3% seen in 1995. The 100-day ROC has only hit 9.9% but we need to give this measure more time to compare it to the returns of 17.6% in 1995 and 26% in 1987.
The S&P 500 has pushed some technical indicators to extreme overbought readings that are often times seen at the beginning of a major bull market. For instance, the 14-day relative strength index (RSI) almost hit 80 on Oct. 26, slightly exceeding the level in January, 2004, and November, 1998, and the highest since late 1996. The 6-day RSI rose to 90 on the same day and that was also near levels seen in early 2004, 1998, 1995, and 1987.
Many times coming out of a four-year low, the market appears to go too far too fast, pushing the daily technicals to extreme levels. The pullbacks are shallow or almost nonexistent, and those not fully invested remain on the sidelines hoping for a better entry point that never comes. Since the small pullback in late September, every pause in this rally, whether on an intraday basis or a closing basis, has found support at the very short-term 10-day exponential moving average (EMA). Many times during intermediate-term advances, the pullbacks will fall to at least the 20-day EMA if not the 50-day EMA.
That's not the case this time, and in fact, the slope of the S&P 500's advance has gotten steeper. The slope of the advance got steeper in late September, and then got even steeper towards the end of October. Multiple changes in slope during an uptrend indicate to us that more money is starting to come in from the sidelines, as investors start chasing the rally. If the slope gets too steep, it may be a sign that a more substantial pause or pullback will occur.
Because many are on the sidelines, some sentiment indicators have remained fairly bearish, while others are just not swinging fervently to the bullish camp as of yet. This indicates to us that the rally has further to go, and that many just don't believe prices can continue to advance. The CBOE put/call ratios, which hit record levels in May and June, remain fairly elevated, and are nowhere near levels that have preceded intermediate-term declines. The 10-day exponential CBOE put/call ratios is still at 0.86, well above the range of 0.60 to 0.70 that have marked intermediate-term peaks over the last 5 years. The 30-day CBOE put/call ratio is still up at 0.90, well above levels between 0.70 and 0.80 that have preceded market peaks.
While these p/c ratios are well off their recent peaks of 1.09 for the 30-day and 1.20 for the 10-day, they have further to fall, in our view. As this bearish option sentiment unwinds, it creates a tailwind for stocks, in our view. Put options are sold while call options are bought, adding fuel to the advance.
The S&P 500 has run up to an initial target we recently set of 1389. This target was derived using Fibonacci projections based on the width of the May to July correction. Multiplying 0.618 by the width of the latest correction (102.07 points) and then adding this to the breakout point or the high in May, gave us a measured move to 1388.84. The close on Thursday was 1389.08. Therefore, a pause/pullback in the uptrend would not be surprising, in our opinion. The 10-day exponential moving average sits at 1373, while short-term trendline support comes in at 1375 and 1370. A decline down to the lower trendline, and projecting out a week, would target the 1350 level.