SPY Price Projection for The Rest of 2014

Click on Chart to Enlarge

Over the last couple days I have created what I believe would be a relatively close projection of upcoming market activity  IF...... the bull market high has completed in September here in the S&P 500.

Without spending a lot of time covering everything that I've looked at other than the few posts I've recently made about the subject, I will give a few key summary points.

1. While the current market decline is larger and faster than anything we've seen since 2013 began, it is not larger than the May-June 2012 decline and certainly not larger or faster than the August 2011 decline.  So it is unlikely from a logical standpoint, that the bull market psychology is complete - EVEN IF the price high has already been made.  This makes it more likely that price may consolidate to a lower high before a much larger and faster downward price move occurs which creates logical confirmation of a new bear market.
2. Seasonal tendencies are for market lows to occur in October and to experience rebounds.  Also seasonal tendencies are for markets to rally or hold up well into the Christmas/New Year's time frame.
3. Real money sentiment is clearly stretched to a statistical extreme of pessimism given the bull market trend.  And since the price psychology has not clearly turned down, it seems likely to me that the market will rebound, but the rebound may now take on a more corrective/overlapping character rather than a V-bottom or sustained directional rally off the low.
4. The move down off the September high appear to have an expanding bias, and tops or bottoms are more likely to end with a contraction (like an ending diagonal, etc).  Expanding activity is more indicative of a new pattern or trend.  So I think it is likely that the recent low will be retested or slightly undercut before a more lasting rally occurs.
5. There is not yet daily time frame bullish divergence on this decline, making it more likely that prices will retest the low or remain rather range bound for several weeks as opposed to a V-bottom.
6. The VIX/VXV ratio has been above 1.00 for several days which suggests to me based on past behaviors that prices are likely to stabilize.  The ratio has not tended to stay above 1.00 for weeks, and even if volatility remains higher, it would make more sense here that the initial directional move is largely done and some decline in the ratio is expected.

Click on Chart of LQD/JNK to Enlarge

This chart is the LQD fund divided by the JNK fund.  LQD is a lower interest "safer" fund.  JNK is a higher interest "riskier" junk bond type fund.  The chart has a few notes, and maybe I should have made the chart of JNK/LQD for easier comparison with price, but the obvious point here is that at the September price peak in stocks, the risk behavior did not increase.  In fact there was the most pronounced divergence in several years.  That has now created the largest rise in the ration in 3 years.  If there is a consolidation followed by a new high for this LQD/JNK ratio, we would have added confirmation of a new dominant trend in market psychology and interest rate behavior towards risk aversion and a flight to safety.  This would make sense if stock prices have peaked and headed lower in coming months.

Click on Chart to Enlarge

This chart is similar to the last one but shows the risk behavior divided by the safety behavior.  This chart is the XLY consumer discretionary fund, divided by the XLP consumer staples fund.  From the chart, it is evident that the ratio has expanded as the bull market has progressed.  Then, at the summer highs, the ratio peaked sharply lower than in the spring.  This has now been followed by a break lower in the ratio.  Again, this is a simple measure of risk versus safety investing, with the indication that a new trend towards safety and away from risk is likely at hand.

Now another chart that looks essentially the same but I won't reproduce here, is the Nasdaq volume/NYSE volume which again shows an element of growth versus safety.  That chart also did not make higher highs this summer compared to this spring.  So here again, there is some indication of waning activity in the more risk/growth oriented stocks versus the more stable, lower risk stocks.

All of these indications suggest to me that the shift towards bear market behavior is on and prices have likely peaked.  We currently have an initial price burst to the downside suggesting a top may be in place as well.  So I will move forward under this outlook, with the major goal of identifying high quality times to short the market or purchase put options in anticipation of a major move to the downside in stocks.

Equity Put/Call Ratio At Multi Year Lows

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The equity put/call ratio put in a very low reading yesterday at 0.38.  And the chart above shows the 10 day average at a multi year low and outside its standard deviation band.  These are further signs building a case that stocks are nearing an optimistic extreme.

The other side of the equation is that stocks are at all time highs and so optimism is warranted here.  As I always point out, it is not the extreme that typically coincides with a high or low.  There is often a period of slowing of market action and development of lesser sentiment extremes which diverge with continued price highs that are the better indication that the time window is narrowing in on a trend change.

From extensive experience monitoring these ratios, my opinion is that extremes like this are good places to reduce positions.  In these cases, sell out partially of the market.  It is true that sometimes trends only pause and your stocks will continue to move big.  So that is why I always hammer home the idea that a trailing stop or stop adjusting mechanism be used to allow for major winners to continue.  So the idea is that when the market is at a sentiment extreme, often most of the move is done, and whatever gains come from here, will often be given back and then some at the next correction.  And so even if you partially sell out, you could often buy back the position at a lower price when opposite extreme sentiment conditions show up.