Percent Buy Index Warns of Market Top

247Bull.com Editor: Although investor sentiment has cooled somewhat since its May peak the market is undoubtedly still in overbought territory. With this in mind those putting new money to work should do so with caution. That said, the medium-term outlook for US equities remains positive. Despite talk of tapering, the Fed is likely to continue its QE program well into 2014 and interest rates will remain low for many years. We are also seeing more and more money flowing into the market from investors and money managers who have been sitting on the sidelines in cash. In 2014 we are also likely to begin seeing money flow into US equities from bond investors who are starting to see losses for the first time in 30 years.

The Percent Buy Index (PBI) shows the percentage of medium-term BUY signals for all the stocks in the S&P 500 Index, and the chart tells us if the index is medium-term overbought or oversold. Toward the end of May the PBI hit the highest reading (94.2) in its almost 14-year history.

Generally speaking, the market runs in cycles where it gets better and better until its as good as its going to get. Then it turns and gets worse and worse until it is as bad as its going to get. The PBI helps us discern approximately where the market is in this irregular cycle. When the PBI reaches extremely high levels, a market correction or consolidation clears the extreme overbought readings. Currently, the price index is also overbought, being at the top of a long-term rising trend channel.

SPX Percent buy index - 10 June 2013

When we see such a long period like this, we need to remind ourselves that we will get a sense that things happen more quickly than they actually do in real time. For example, the 2011 top took about six months to play out, and the 2007 top took almost nine months. We can’t expect that things will happen as fast as we are anticipating.

Conclusion

The price formation and PBI offer strong evidence that the market needs to digest or correct the external and internal extremes it has reached. We don’t know what form that will take, but, at the very least, it is likely that the advance will be stalled for some time.

Carl Swenlin | president and founder of DecisionPoint.com

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