Charts and data suggest further consolidation for the markets

The valuation gap has narrowed on the S&P 500, while broadly negative investor sentiment, a contrarian signal, remains encouraging.

Any good for a resumption of the rally? Not so fast…

Friday’s trading session ended with all index charts in short-term neutral patterns while several saw bearish stochastic crossover signals generated. Meanwhile, the data finds most McClellan OB/OS oscillators in overbought territory.

As such, we expect further consolidation from the recent rally to occur in the near term.

On the charts

Source: Worden

All major equity indices except the Dow Jones Transportation (-4.74%) (see above) closed higher on Friday with generally positive internals as trading volumes declined on both exchanges.

All closed near their highs for the day, except for the Dow Transportation, which closed near its low as it breached its uptrend and near-term support. The Transportation stock moved its short-term trend from neutral to positive, joining the rest of the charts in this condition.

Cumulative market widths saw some improvement with the All Exchange, NYSE and Nasdaq neutral as All Exchange and NYSE recovered to their 50-day moving averages.

However, warning bearish stochastic crossover signals have been generated on the S&P 500, DJIA, Nasdaq Composite, Nasdaq 100 and Value Line Arithmetic indices.

Data

The McClellan 1-Day Overbought/Oversold is back in overbought territory for the All Exchange and the NYSE, with the Nasdaq remaining neutral (All Exchange: +53.42 NYSE: +68.05 Nasdaq: +44.38).

The percentage of S&P 500 issues trading above their 50-day moving averages (contrarian indicator) was unchanged at 62% and remains neutral.

The Open Insider buy/sell ratio fell to 47.9, also remaining neutral.

The trendless Rydex ratio (conventional indicator) rose to +0.48 and is neutral on its previous bullish implications near market lows.

Last week’s AAII Bear/Bull Ratio (opposite indicator), while declining, remained bullish at 1.65, while Investors Intelligence Bear/Bull Ratio (opposite indicator) was at 35.31/36.3, near the highest levels of fear seen four times in the past decade, each of which was also followed by a notable rally like the one recently achieved.

Market valuation and returns

The valuation gap narrowed with Bloomberg’s consensus 12-month earnings estimate for the S&P 500 rising to $233.82 per share from $228.42. As such, the S&P’s leading P/E multiple stands at 19.4x, with the “rule of 20” finding an approximate fair value at 17.6x.

The S&P’s forward earnings yield is now 5.14%.

The 10-year Treasury yield closed higher at 2.38%. We consider resistance to be 2.64% while support remains at 2.0%.

Short-term outlook

Cautious OB/OS levels and stochastic signals are, in our view, somewhat offset by rising earnings estimates and continued bearish crowd sentiment. Their combination suggests that the greater the near-term consolidation the greater likelihood before further progress can be made.