Excessive Optimism, Record Highs, And Warning Signs

November was a spectacular month for the stock market. Bolstered by newfound vaccine optimism and the flow of stimulus from the world’s central banks, the S&P 500 closed on Monday with a more than 10% monthly gain, finishing its best month since April.

In general, however, it is always best to practice caution when the markets become too giddy. Readers of our latest award-winning Wellington Letter (published November 29th, 2020) knew about the bearish warning signs we saw late last week, ahead of Monday’s (November 30th) decline.

The major indices have soared over the past three weeks, with some breaking out to new record highs as we had expected in early November.

While we were able to capture some nice gains on the upside this month, a few of our warnings appear to be coming to fruition.

The two-day chart below of the S&P 500 shows why a pullback, perhaps sharp, could occur soon. Was Monday’s decline the start of it?

Take a look at the upper trendline of the S&P 500, which connects the February high with the September 1st high. That line should be resistance soon.

The November 9th high, followed by an intraday pullback, formed a negative candlestick. The top of that should also be a brief barrier now.

Furthermore, the VALUG Index, which we believe to be more important than the S&P 500 since it incorporates over 1600 stocks using an equal-weighting method, is now very close to its February high. It is not influenced by the disproportionate weighting of the mega-caps in the other widely watched indices. Below is its daily chart:

In early February, just prior to the market’s historic crash, we noticed a troubling divergence: the VALUG Index was making lower highs while the widely watched indices were on the rise. This bearish divergence, along with several others, clued us in that a big decline was on the way.

In fact, look again at the S&P 500 chart above to see how timely our "sell" signal was. We advised our valued members to sell and sell short in order to profit from the market plunge.

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