S&P 500: Short-and Long-term Risk vs Reward Analysis

it happened again: The S&P 500 erased a month worth of gains in just 3 days. Being aware of the up side potential compared to down side risk is always a good idea, but especially now.

Let’s objectively assess bullish and bearish factors to determine up side potential vs down side risk for the short-and long-term.

Up Side Potential – Short-term

The October 20 Profit Radar Report published the S&P 500 futures chart below and stated that: “A close above 3,002 (blue triangle) could eventually lead as high as 3,187.75 (3,167.74 for S&P 500).

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The S&P 500 came within 12 points of this target and then dropped 84 points in 3 days (as projected, see last chart of this article). Based on the above projection, near-term up side potential is limited.

Up Side Potential – Longer-term

On November 25, the VIX closed below 12 for the first time in 3 months. Over the past 20 years, this has happened 8 other times. 1 year later the S&P 500 traded higher every time (the blue lines below highlight the instances since 2013).

On November 25, the Russell 2000 reached a new 52-week highefor the fist time in a year. Over the past 20 years, this happened 5 other times. 1 year later, R2K traded higher 4 of 5 times.

For the first time since August 2018, the monthly MACD histogram for the NY Composite crossed above 0. The blue lines below highlight times when the MACD histogram exceeded 0 for the first time in a year. This signal was rare (only 6 times since 1980) and always followed by gains 1 year later (on average 16%).

Short-term Down Side Risk – Short-term

The November 24 PRR mentioned that VIX hedgers held a record amount of VIX positions and warned: “The last two times this happened, the VIX spiked and S&P 500 took a nasty spill.”

From November 27 – December 3, the VIX soared as much as 50%. This may have satisfied the need for a VIX spike already, but more could still be to come.

Longer-term Down Side Risk

The November 20 PRR noted that: “Unlike stocks, junk bonds have been trending lower. The chart below plots the S&P 500 against the SPDR High Yield Bond ETF (JNK). The blue boxes highlight other periods where JNK trended lower while the S&P trended higher. It usually and eventually led to stock market pullbacks of various degrees.”

It is difficult to put a time-frame on this ‘setup’ as the bearish divergence could be followed by weakness sooner or later.

Conclusion

When compiling my forecasts I look for ‘signal clusters.’ Those are times when indicators and studies coherently suggest a specific performance over a certain time frame.

Right now, a cluster of bullish studies suggests that stocks will be higher about 1 year from today.

Another cluster of indicators projects lower prices over the next 3 month. This cluster, however, is in conflict with the strong momentum market we’ve seen since early October.

In short, the weight of evidence suggests that pullbacks over the next 3 month are an opportunity to buy.

The yellow projection below, published in the December 1 Profit Radar Report, outlined a path in harmony with a number of indicators.

As you can see, the projection correctly captured the decline from 3,150 to below 3,100. Another rally to the high is quite possible and – if all goes according ‘to plan’ – should be followed by another pullback, potentially a much deeper, but also temporary one.

Continued updates, projections, buy/sell recommendations are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s evaluation of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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5 ‘Keep it Simple’ Stock Charts and 1 Bearish Constellation

The rally from the June 3 low has created many bullish price and breadth patterns and studies (5 of them are discussed here). The market has followed through on them thus far.

However, the short-term Elliott Wave structure does not look bullish, and the long-term projection published in the June 2 Profit Radar Report (shown here) points to a serious speed bump.

In short, there is a measure of conflict between indicators. When that happens, I like to go back to the basics and keep it simple.

Resistance

The DJIA shows probably the most important resistance range to watch: around 27,300.

Support

The S&P 500 shows some important support levels to watch: around 2,910 and 2,875.

Short-term Trend Channel

The June 23 Profit Radar Report used this chart to simplify the short-term: “A break below channel support would unlock a pullback. The wave labels show the most bearish EWT-based option. It’s not ideal, but it seems more likely than other options.”

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Trend channel support failed the next day and unlocked the biggest pullback of June. It is possible to count the decline from June 21 as 5 waves, which cautions that the trend may have changed from up to down.

Leader Fatigue

The rally from the June low has been led by defensive sectors like consumer staples. Contrary to popular belief, such (defensive-led) rallies are statistically not doomed to fail.

However, the Consumer Staples Select Sector SPDR ETF (XLP) carved out a pattern with a lot of bearish potential. I recommended to go short at 59.07 on June 13. The stop-loss is now set at breakeven, which allows us to ‘play with house money.’

Overlap

Small cap stocks represented by the Russell 2000 ETF (IWM) are lagging. In fact, IWM fell below the June 5 high. If one wanted to count the June rally as 5 waves, June 5 would be wave 1, but yesterday price dropped below the June 5 high. This creates a bearish (wave 4 / wave 1) overlap (blue arrow) that’s not allowed and voids a short-term bullish Elliott Wave count.

Bearish Constellation

Not only small caps are lagging. The transportation and banking sector are too (see chart below).

Only two other times (July 1990 and July 1998) has there been such a big divergence between the S&P 500 and small caps, transportation, and banking. This is a small sample size, but it led to a rocky and negative performance over the next quarter.

Conclusion

Even during times where there is conflict among indicators, going back to the basics provides some general guidance.

It will take a sustained move above resistance to unlock higher targets, and a break below support to unlock lower targets.

Another big but temporary drop would certainly clear up the structure and provide a lot more certainty, but we’ll let the above levels indicate whether it will happen.

Continued updates are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s evaluation of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

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Russell 2000 and Transports at Crossroads?

The Russell 2000 (RUT) and Dow Jones Transportation Average (DJT) racked up some pretty significant losses since their 2015 all-time highs.

From the 2015 peak to the 2016 trough, the RUT lost as much as 27.23%, DJT as much as 31.22%. The S&P 500 lost ‘only’ 15.20%.

It was the prevailing opinion for much of 2015 and early 2016 that the RUT and DJT would lead U.S. stocks into the next bear market.

It is correct that small cap underperformance is one of the stages of an aging bull market, and in line with our analysis (view 3 Stages of a ‘Dying’ Bull Market). However, the timing for an immediate bear market didn’t seem right.

The February 11 Profit Radar Report listed six reasons why stocks are likely to rally. The ‘six reason buy signal’ is also discussed here.

After almost three weeks of rising prices (RUT up 11%, DJT up 17%), the RUT and DJT have arrived at their first inflection point.

Russell 2000 (RUT)

The RUT is back-testing the ascending green trend line (currently at 1,045), which originates at the March 2009 low. Sustained trade above this trend line is bullish until the signal is reversed.

Dow Jones Transportation Average (DJT)

The DJT is threatening to break above the 7,400 – 7,500 zone. This zone served as support a few months ago.

This is not only price resistance for DJT, it’s also momentum resistance as DJT’s prior rallies failed at similar RSI readings.

Conclusion

When the Profit Radar Report issued a buy signal at S&P 1,828, it wasn’t clear whether this rally would only move to the initial up side target at 1,950 or beyond.

Based on investor sentiment, there was a distinct chance that a runaway rally (with higher targets) would develop.

The S&P is not in the clear yet, but the RUT and DJT charts may help gauge the broad market’s prospects. RUT and DJT above their respective resistance levels is a positive for the S&P and other indexes.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

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The Best Place for Tell Tale Signs: Small Caps?

The S&P 500 inched up a pitiful 0.03% last week. The Russell 2000 rallied 2.33%.

But that’s not the only reason small cap stocks are worth a second look right now.

As the weekly bar chart below shows, the Russell 2000 (NYSEArca: IWM) is bumping against significant double resistance.

The November 29 Profit Radar Report stated that: “Last week’s push higher happened during a holiday week on low volume, and therefore needs confirmation. RSI just barely failed to issue a bullish confirmation.

Small caps enter a bullish 1-month window (of relative outperformance compared to large caps) in mid-December. However, prior to catching this bullish seasonal tailwind, small caps will likely have to digest recent gains.”

This digestive period is now underway. Regardless of the immediate down side risk (which should be limited), the Russell 2000 sports the most pronounced overhead resistance.

A strong move above resistance may be the best tell tale sign of further gains. The Profit Radar Report will monitor the strength of any breakout to assess its longevity.

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

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Is the Russell 2000 Forming a Bearish Wedge?

The Russell 2000 sports an interesting chart.

Here is what Wednesday’s (April 15) Profit Radar Report observed:

The Russell 2000 rallied to a new all-time high today. The chart shows a wedge, which is generally considered a bearish formation. RSI did not confirm today’s high and MACD is barely positive (blue bubble). The 2-day RSI is short-term overbought at 96. The Russell 2000 also touched the upper Bollinger Band today.

History suggests a pullback, sooner or later. Aggressive investors may short the S&P 500 (NYSEArca: SPY) or Russell 2000 (NYSEArca: IWM) against today’s high.”

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Well, the Russell 2000 pullback happened sooner rather than later.

However, the Russell 2000 is still within the rising wedge formation (and above wedge support). There are two ways to draw wedge support (solid and dashed green line).

Notice also the open chart gap created by today’s massive gap down. Such chart gaps have a tendency to be closed – sooner or later.

In summary, while today’s drop comes at the right time to start the initial validation process of the bearish rising wedge, the Russell 2000 still needs a break below support (on increased volume) to unlock the potential for much lower targets.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Small Caps Lead Market – Good or Bad Omen?

The Russell 2000 index of small cap stocks just pushed to new all-time highs.

Is this bullish for stocks?

To find out, I’ve plotted the S&P 500 against the IWM:IWB (small cap/large cap) ratio.

IWM is the iShares Russell 2000 ETF (NYSEarca: IWM). IWB is the iShares Russell 1000 ETF (NYSEArca: IWB).

Based on the ratio (currently at 1.06), the recent outperformance is by no means extreme.

What if we pretend for a moment that small cap outperformance was extreme (reading of 1.10 or greater)?

The red lines mark prior periods of small cap outperformance (IWM:IWB > 1.10). The S&P 500 (NYSEArca: SPY) couldn’t care less.

If anything, one could make an argument that extreme small cap underperformance works as buy signal. The dashed gray lines highlight readings smaller than 1.03.

 

The gray overlay of the iShares Russell 2000 Small Cap ETF (IWM), makes it clear that IWM is only trading 3% above where it was a year ago. The S&P 500 gained 13% since March 2014.

Small caps are often portrayed to be the engine that pulls the train (or at least the canary in the mine), but that’s not true.

We dispelled this myth in July when many jumped on the ‘small caps are down, the market’s going to crash’ bandwagon.

Perhaps recent small cap outperformance is a reflection of the idea that a strong dollar hurts multi-national large caps with overseas income more than small domestic companies.

But what happens if dollar strength takes a breather?

One more thought: Historically, small caps tend to under perform in the later stages of a bull market.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

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Is the ‘No Guts No Glory’ Small Cap Trade Over?

Small cap stocks tend to outperform large cap stocks starting in mid-December. After an incredible second half of December, stocks hit a wall and started to tumble and investors’ guts are being tested.

The December 15 article “Small Caps – The December ‘No Guts No Glory’ Trade?” identified buy levels for the iShares Russell 2000 ETF (NYSEArca: IWM).

Small cap stocks have a tendency to outperform large cap stocks for a fairly short period of time starting in mid-December.

Executing this trade took guts this year around, because the first half of December was pretty rough for stocks.

Nevertheless, in the middle of the month stocks bounced back strongly and the Russell 2000 started outperforming the S&P 500.

The chart below plots the SPDR S&P 500 ETF (NYSEArca: SPY) against the iShares Russell 2000 ETF (NYSEArca: IWM).

The Russell 2000 peaked on December 31, but the price action going into this high didn’t look right.

The December 30 Profit Radar Report warned that: “The Russell 2000 is near it’s all-time high, but RSI is lagging severely. We are closing out the IWM trade for a 5.3% gain.” We closed all are long equity position out at the same time.

Small caps (IWM) are holding up better than large caps (SPY), but we are glad to be out of stocks in general.

A more detailed 2015 S&P 500 forecast is available here: Initial 2015 S&P 500 Forecast

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

Small Caps – The December ‘No Guts No Glory’ Trade?

Historically, December is a good month to own small caps. However, the tendency for a nasty mid-month pullback is often overlooked. Will this correction send small caps even lower, or is it a good time to buy?

December has a reputation to be a good month for stocks, but that reputation is taking one on the chin as we speak.

In reality, December sports some seasonal ebbs and flows often ignored. Stocks tend to rally in the first part of the month, correct in the middle and finish strong.

Small caps in particular are subject to this up-down-up pattern. The December 7 Profit Radar Report referred to this tendency when it wrote that:

Small cap stocks tend to shine in December. History suggests we may see a pullback before the next surge. The green circles mark potential entry levels.

The updated Russell 2000 chart below includes the green circles mentioned in the December 7 PRR update.

The Russell 2000 in particular and stocks in general fell more than many expected, turning the potential year-end buy signal into a ‘no guts, no glory’ trade.

It certainly takes guts to push the buy button after this nasty sell off. Although seasonality suggests a favorable outcome for small cap buyers, it’s prudent to wait for technicals to confirm the initial stages of a reversal.

The iShares Russell 2000 ETF (NYSEArca: IWM) and Direxion Daily Small Cap Bull 3X ETF (NYSEArca: TNA) are two ways to play strong year-end small cap seasonality.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF to get actionable ETF trade ideas delivered for free.

Bullish Russell 2000 Signals – Will They Last?

The Russell 2000 has weighted down the broad stock market since March. Now, for the first time in a while, the Russell 2000 is actually outperforming large cap stocks. Does that mean that small caps will lead the market higher?

The Russell 2000 is showing signs of life, after months of underperformance relative to the S&P 500.

The Russell 2000 is one of the only indexes (along with the MidCap 400) that painted a green reversal candle (see chart insert).

Prior to erasing last week’s losses, the Russell 2000 also dipped to a 52-week low. A weekly reversal after a 52-week low is also considered a selling climax.

605 stocks recorded selling climaxes last week. This is the highest count of selling climaxes since October 2011, which marked a major bottom (more details here: Selling Climaxes Soar to 4-year High).

From a technical perspective, here are a few Russell 2000 developments to keep in mind:

  • Bullish: Last week’s green reversal candle pushed the Russell 2000 back above support at 1,080.
  • Almost Confirmed: The chart below shows one indicator I like to monitor when it comes to spotting trend changes. On the short-term daily chart, this indicator requires a close above Friday’s high. The same is true for the weekly chart.
  • Confirmation Needed: The IWM:IWB ratio shows the performance of small caps (IWM Russell 2000 ETF) relative to large caps (IWB Russell 1000 ETF). The IWM:IWB ratio is about to test prior support, now resistance.

Unless the ratio can move above 1.05, small caps are likely to continue underperforming their large cap cousins.

In short, the Russell 2000 is showing strength, and odds of continued up side are increasing.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

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Obvious Yet Hidden – The Long-Awaited S&P 500 Correction Already Happened

A lot can happen when you’re not looking, but a lot can happen even when you are looking. While everyone’s been waiting for the illusive correction, the S&P 500 ‘Richter scale’ actually shows the correction has come and gone.

If you define correction as a 10% drop, the S&P 500 hasn’t had one in well over 1,000 days.

This is the longest correction-free streak since the 1,127-day run from July 1984 to August 1987.

But, corrections are not like annual holidays, they are more like earthquakes. Corrections don’t appear on schedule and they are not always felt the same way.

Although the Richter scale may register a magnitude 3.5 earthquake, it may not be felt by all residents.

The same is true with market corrections. Not all corrections are created equal, and the ‘S&P 500 Richter scale’ may have registered a correction that wasn’t felt by every investor.

In fact, the chart below shows a perfectly legitimate correction period. How so?

Via the May 14 Profit Radar Report, I explained the ‘covert’ correction as follows:

I’d like to take a moment to talk about the potential for an extended rally. For many months analysts have emphasized (and continue to emphasize) the need for a 10% correction. There are two ways stocks can correct: 1) Price 2) Time.

A price correction is straight-forward and easy to spot as stocks simply shed value. Time corrections are often overlooked by the investing masses as prolonged sideways trading covertly digests oversold readings and excessive sentiment.

What we’ve seen since February delivers both. The S&P 500 and Dow Jones have treaded water while the Nasdaq-100 and Russell 2000 already lost as much as 8.67% and 8.71%, the biggest correction in well over a year.

As pointed out in a number of prior Profit Radar Reports, investor sentiment has dropped quite a bit. The percentage of AAII bears is down to 28.34% and various media outlets have boldly gone on record predicting a crash or severe correction.

The chart below plots the S&P 500 against the CBOE Equity Put/Call Ratio. Prior corrections were preceded by a put/call ratio around 0.5 or below (= option traders buy two calls for every put). Today the put/call ratio is at 0.72, a level that’s indicative of a low more than a top.”

Below is the chart referenced in the May 14 Profit Radar Report. It shows that the S&P 500 corrected internally. 3 ½ months of sideways trading created enough of an oversold condition (based on option trader sentiment) to serve as a foundation for the next rally.

In addition, the Russell 2000 lost as much as 10.75% from March 4 to May 15.

In short, there was a correction. For the S&P 500 it was a correction by virtue of time, not price.

From April to July the S&P 500 tagged on 160 points. Now we ask if the market is due for another correction or if it will keep grinding higher?

To help discern, we look at the same indicator that projected a rally without price correction months ago. This is probably one of the most unique (und recently accurate) indicators you’ll ever see:

The Only Indicator that Foresaw a Persistent S&P 500 Rally Without Correction

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.