Stocks: Several Factors Are Pointing To Multi-Year Extremes

Robert Kelley, one of our Pro Service team senior analysts, tells you how he uses so-called divergences between related markets -- and what they're telling him now about the markets he follows.

 

[Editor's note: A text version of the interview is below.]

Alexandra Lienhard: I'm Alexandra Lienhard, today I'm joined by Robert Kelley who is a senior analyst on Elliott Wave International's Pro Service team. Now Robert, you follow market sentiment quite closely and look for extremes. Is there anything standing out for you in the markets you follow?

Robert Kelley: Definitely. Right now we're seeing multi-year extremes in the stock market. I'm talking about things like the put-call ratio, the VIX is extremely low, the position of the Daily Sentiment Index (trade-futures.com). The 10-day moving average for the Daily Sentiment Index for the S&P is the at the highest level since December 2013. The 10-day put-call ratio, the CBOE, is at the lowest level -- well, it has been in the last few days -- since two years ago.

All these indicators are suggesting that psychology of stock market investors is extremely overdone right now, and therefore I'm looking for a bit of a correction starting very soon.

Alexandra: Talk to me a little bit about divergences. I know that's something you look for as well.

Robert: The neat thing about the stock market, which is kind of different from any other market like currencies or commodities, is that you've got so many different indexes and different patterns between and among them. And one thing I've noticed doing a lot of back testing-type of research is that when one index is making a new high and something related to it is not -- for example, something like the Dow and the NASDAQ 100 are two of the ones that I focus on, the NASDAQ 100 is 100 stocks and the Dow is 30 stocks so it's easier for those indexes to diverge for each other because they're controlled by fewer stocks. So when you see a new high in the Dow and the NASDAQ is not making a new high, quite often that's a sign of a waning trend. What I tend to look for in a turning point is if the Dow is the strongest and the NASDAQ is lagging. I wait for the Dow to kind of exhaust its momentum. And then when I see the Dow turn, I go, 'This is a good time to go short the market.'

Alexandra: And is that common, is that something you see often?

Robert: It happens, I would say, several times a year on a really prominent basis. It's not happening all the time -- if you look at a 5 minute chart, you'll see it a lot, but I'm talking about on a daily chart, you'll see these divergences happening say, once a month or so. When it's really pronounced and prominent, that's often a really significant turning point.

Alexandra: And are divergences more powerful if they're on longer-term charts versus shorter-term charts?

Robert: To a certain extent. I like the daily chat time frame because that's where it's recent enough but not too short-term. If you look at a monthly chart, yeah, timing on a monthly chart is a slow process. You're talking months. But a daily chart gives you a time frame that's actionable.

Alexandra: And let's widen out a bit, you cover the World Stock Index for our Global Market Perspective. How's the world looking right now, Robert?

Robert: The interesting thing is the U.S. market has been really strong. And basically making new all time highs. The World Stock Index, which I cover for our monthly publication, Global Market Perspective, is quite a way from its high. Not that that means it can't go up for a while. But, U.S. market is really kind of diverged -- there's a divergence coming in -- from a lot of the world markets, the World Stock Index specifically. The timing now is to follow when the uptrend is going to exhaust itself. It could go for a little while, but I think the bigger picture is saying we're near the end of it.

Alexandra: And let me ask you this, does the U.S. lead the world market, or does the world lead the U.S.?

Robert: Well the U.S. has been one of the stronger markets just because I guess the economy here is less burden with regulations than may other countries. But it's a large market, dollar-wise, valuation, so it tends to have a big impact on world markets. But every country tends to do its own thing, they just tend to go in the general direction, but every country depends upon what's happening there.

Alexandra: Well thanks Robert, I appreciate you elaborating on what you're looking at.

Robert: Great to talk to you.

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