By Decision Point:
Last week we were looking at a bearish reverse flag formation, but this week prices broke above a short-term declining trend line, effecting a bullish resolution of the flag and changing the short-term outlook to bullish. This was confirmed by a PMO (Price Momentum Oscillator) buy signal, generated as the PMO crossed up through its 10-EMA.
The negative side of the picture is that volume accompanying the breakout and subsequent advance only has been averaging about 85% of the 250-EMA of daily volume, which does not reflect broad confidence in the move. This, plus other evidence we will discuss, makes me think the breakout could be a bull trap.
Our market posture for the S&P 500 remains neutral; however, our Thrust/Trend Model (T/TM) could generate a buy signal if positive price action can continue and the Percent Buy Index (PBI) can cross up through its 32-EMA. To clarify, the PMO buy signal is one-half of a T/TM buy signal. The PBI is harder to generate, and is intended to keep the T/TM from reacting too quickly to short-term rallies.
Additional negative evidence is that most of our short-term indicators are very overbought, as illustrated by the CVI (Climactic Volume Indicator) and STVO (Short-Term Volume Oscillator) charts below. Until those conditions are relieved, it will be difficult for the market to make upward progress. And it may take a price decline to clear the conditions. In this regard, it is possible that the support implied by the recent lows will be retested, if not violated.
Finally, my cycle projections still call for a 9-Month Cycle low around the first part of April.
Bottom Line: The market can often overcome short-term overbought conditions, but most often these conditions are cleared by price pullbacks. The recent breakout could reveal itself as a bull trap.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.