STOCK ALERT: Time to Slash-and-Burn
Last week, the Fed spoke and they said a mouthful.
Minutes from the January Federal Open Market Committee meeting clearly stated the Fed would take a more “patient” approach toward interest rate hikes due to “risks and uncertainties in the outlook.”
The Fed is echoing the time-honored phrase “Give the people (or investors) what they want.”
The Fed has done so by skipping another rate hike in January. Now they’re fessing up as to the reason why.
Here’s Another Well-Known Phrase: Sell the News!
Now that the Fed has delivered against the market’s expectations, it’s a good time to fade the recent rally.
I’m not saying jump ship entirely, mind you. But you need to be more cautious and perhaps take some profits off the table.
In a previous Wealth Watch article, I cautioned you that “stocks are as overbought now as they were oversold in late December.”
More than 90% of the stocks in the S&P 500 Index were recently trading above their 50-day moving average.
While you could interpret that as a healthy uptrend for stocks, it is also an extreme overbought signal that often leads to a market pullback.
In my previous article, I also wrote: “History says that on average, we could expect a correction of 4–6%,” and in the chart below, you can see the likely path stocks could take from here:
The S&P is running smack into stiff resistance at the 2,800–2,820 level (red line). That’s exactly where previous rally attempts failed in October and November last year just before the big December market drop.
I’m not expecting a repeat of the dismal December correction that saw the S&P drop nearly 15% in just a month. But a 4–6% pullback to key support at the 2,600 level (green line) would not surprise me one bit.
Now take a closer look at the stochastic oscillator shown in the lower panel of the chart above.
Stochastics are a time-tested technical indicator used by chartists since the 1950s to gauge how overbought or oversold stocks are. They are simply a measure of price momentum, comparing the current price with a range of prices in the recent past.
The indicator oscillates between zero and 100. When the indicator crosses up from below 20, it’s a buy signal, which was flashed at the bottom in late December. And when stochastics cross down from above 80, it’s a sell signal.
As you can see, the indicator triggered sell signals twice, in late January and again this month. The indicator crossed back above 80 both times but now is heading down from a lower high again for the third time.
Perhaps the third time’s the charm.
History also suggests after a market rally of the magnitude we’ve had stocks often give back some of those gains.
Looking at the database tells me once stocks get this overbought on the upside, the market pulls back 3–5% over the next one–three months about two-thirds of the time.
If it plays out accordingly, we should see a dip in the next month or so that should hold at the 2,600 level on the S&P.
Call it a pause that refreshes stocks for more gains ahead.
Alternatively, we could see the market churn sideways for a few months before the rally resumes in earnest.
Either way, my fearless forecast is be cautious near term, but be ready to buy the dip once this price action ensues.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch
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