Get Cautious on the Market

The easy money has been made in both directions. There are times when odds strongly favor a rally and it pays to be an aggressive buyer. There are times when odds strongly favor a selloff and it makes sense to sell out and go short. After last week's sharp rally off of multi-month lows, right now the best bet is the sidelines.

Back in October as the market was reaching all-time highs and becoming quite stretched in the process, there were plenty of indications that some kind of topping pattern was building and that risk of a correction was on the rise. It didn't take long for the bears to be vindicated, as the market collapsed in one of the sharpest selloffs in years.

That collapse, which culminated in new multi-month lows in the major averages early last week, produced conditions for a rally. Not least among these was another better-late-than-never Dow Theory sell signal, which helped convert a few more bulls to the bearish camp right at the bottom. Of course, that's the kind of thing you need to set the stage for a sharp recovery: lots of bearishness, breaks to lower lows and the cracking of moving averages, etc.

There were other telltale signs that the market was poised for a recovery. We had repeated oversold readings in the oscillators and then, of course, there was the meltdown in the Russell 2000, which returned the index to its prior lows for the year. Last Monday, I highlighted the Russell 2000 as a leading index, and boy did it call the turn last week.

Recall there was already a triple-bottom low in place in the Russell 2000 from the week before. Then late last Monday, the market collapsed to lower lows, and the Russell 2000 made marginally lower lows for the year, cracking its previous triple bottom. But on Tuesday morning, following the gap-up opening, the Russell 2000 and only the Russell 2000 pulled back to fill its opening gap. The index then proceeded to make fractionally lower lows.

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At the time of publication, Schiller was long S&P, NDX, Russell 2000 and Dow mutual funds but only up to 60% invested; and had bullish option positions in the QQQQ and SPY puts, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.