SPY Turned Back by a Gap
In last week's Market Outlook, I highlighted a head-and-shoulders top that had formed in SPDR S&P 500 (NYSE: SPY). The price target for that pattern had been achieved and SPY was moving toward resistance defined by a gap. The gap is at the neckline of the head-and-shoulders, giving it additional significance. That chart has been updated to include the most recent price action.
After meeting resistance, SPY fell and ended the week down 1.78%. Small-cap stocks fared worse with iShares Russell 2000 (NYSE: IWM) falling 2.7%. Small caps often lead the market at turning points. Both indexes are more than 4% below their all-time highs reached in the first week of August.
This is still a rather shallow pullback, but the bull market is relatively old and will come to an end one day. This bull market has now been under way for more than four years, and every pullback prompts questions about whether this is the beginning of a bear market.
Since 1928, there have been 22 bull markets, with a bull market defined as a price increase of at least 20% in the Dow Jones Industrial Average over a three-month period. The average bull market has lasted about 35 months and delivered a price gain of 104%, excluding dividends.
The current bull market began in March 2009 (53 months ago), and the Dow gained more than 140% at its high since then. There have only been four bull markets that exceeded the current one in length and four that delivered larger gains.
The bull markets that have been stronger than the current one are shown in the table below:
Three of those bull markets (the ones that began in 1932, 1982 and 2002) started after historic bear markets. The other two came after wars had ended (1946 after World War II and 1990 after the Cold War). So the two longest bull markets have started at the end of wars.
The current bull market more closely resembles the ones that began in 1932, 1982 and 2002, coming after the worst bear market since the Great Depression. In hindsight, its strength was to be expected. Two of the three bulls that began after historic bear markets lasted five years. This current bull market is still more than six months from that milestone.
Given the age of the bull, it is time to start looking for the beginning of the next bear market, which will result in a price decline of 20% or more.
Short-term traders should be considering the recent price weakness as an opportunity to enter short trades to benefit from a pullback. Inverse ETFs like ProShares Short S&P500 (NYSE: SH) can also be used to hedge against the risk of further declines. Long-term investors should await confirmation of a trend change before reducing their exposure to the stock market.
Gold Fades as Global Tensions Subside
SPDR Gold Shares (NYSE: GLD) fell 0.21% last week after volatile trading. Fears of military action against Syria pushed gold higher early in the week. As the likelihood of extended military action declined, so did gold prices. Without a global crisis, gold is likely to trade based on fundamentals, and that could be bearish in the short term.
Demand for gold comes from investors seeking a hedge against inflation or other risks, consumers buying jewelry, and some industrial uses. This demand is met by miners who bring new gold to market and the trading of existing supplies of gold.
Miners and other commercial users of gold often hedge their positions in the future markets, buying futures when they believe prices are low and selling when they believe prices are high. Miners and commercial users are not trading based on concerns about military action or long-term inflation. Their positions are taken based on the supply and demand factors they see in the markets.
Futures markets are highly regulated, and large users of gold and other commodities are required to report their activity to the Commodity Futures Trading Commission (CFTC). Once a week, the CFTC issues a report summarizing the activity in the various futures. The Commitment of Traders (COT) report shows the positions of commercial traders (miners and industrial users in the gold market), large speculators (hedge funds) and small speculators (individual traders).
I convert the raw data into an index that makes it easier to interpret. The latest data, shown in the next chart, indicate that commercials are turning bearish as hedge funds are becoming bullish. In the past, this setup has been followed by lower prices for gold or a trading range where prices move only a small amount.
The index based on the COT data uses a scale of 0 to 100 with 100 being bullish and 0 being bearish. Over time, commercials are generally right and hedge funds, as a group, are generally wrong in this market. Commercials were increasingly bullish as prices fell from their 2012 highs while speculators were increasingly bearish. Since the July bottom in gold, commercials have become less bullish and speculators have more than tripled their positions in the market.
It is rare to see gold prices rise when commercials are bearish. Last week, gold was unable to hold onto gains driven by the possibility of military action. Gold is a market that seems to offer little upside potential for now, and traders should consider other opportunities.