In the past month, we've had quite a rally off the lows--the S&P 500 is up over 25%. Thus far the market's breadth has been keeping pace with the major averages such as the S&P, which I believe has helped keep the rally going. As we head into mid-April, I believe we will likely see a market that is overbought. To determine an overbought or oversold reading on an intermediate-term basis, I use the 30-day moving average of the advance-decline line. In my view, this indicator was grossly oversold in mid-March. I expect it will be overbought sometime just after April's option expiration. Source: Helene Meisler, as of April 9, 2009.
Eyes on the Treasury note
Being overbought alone is not enough reason to look for a market to roll over, in my experience. However, once a market gets overbought, it becomes more difficult to make much more significant headway on the upside. At present, I have my eyes on the yield of the 10-year Treasury note. Several weeks ago it was trading around 3% to 3.10% and backed off rather well. However, it has begun to creep back up. Source: Helene Meisler, as of April 9, 2009. When examining levels on charts, we tend to look at crossing trendlines as meaningful. They are, but when we cross a trendline that is also a resistance or support level, I believe we should have more conviction in that move. In other words, the chart has now "broken" two things at the same time. On the chart of the yield of the 10-year Treasury note, shown above, we see the potential resistance from a few weeks ago in that 3% to 3.10% area, which is also approximately where the downtrend line comes in. Should the yield on the 10-year note cross through 3% to 3.10%, I would consider that an important breakout. In my view, higher interest rates would likely turn into a negative for the stock market, or at least make it more difficult for the market to make progress on the upside.
On the sentiment front
In addition to the potential for higher interest rates, I would note on the sentiment front that Investors Intelligence readings of two weeks ago showed that 31% of those surveyed were looking for a correction. Typically, I use this survey as a contrary indicator, but I have noticed in the past that when the percentage of correction-minded folks reaches over 30%, we tend to see a market correction approximately two to three weeks later. In the chart below, you can see that point A is early July 2007. The S&P was around 1,515 when the survey was released and it proceeded to rally in the next two weeks to near 1,550 to 1,370 in the next five weeks. Source: Helene Meisler, as of April 9, 2009. Point B was May 2008 when the S&P was around 1,400. It did not go higher thereafter and, as you know, we haven't seen that level since. However, in mid-July (six weeks after the reading came out), we fell to 1,214, where we then had a multiweek rally. Point C is the most recent reading. So far, the market's rally has been strong, but I believe the market is heading toward an overbought reading. Bond yields have the potential to start rising and sentiment is such that we ought to see a market correction begin to take shape in the latter part of April.