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U.S. Stocks: Does the Recent Pullback Have More to Go?

Warning signs to keep your eye on

by Alexandra Lienhard
Updated: August 30, 2017

Robert Kelley, the editor of our U.S. Intraday Stocks Pro Service, tells you about a handful of reliable indicators he monitors to help him spot approaching tops and bottoms in the S&P 500, DJIA and NASDAQ.


Alexandra Lienhard: U.S. stocks have seen a lot of chop and change since the S&P topped out earlier this month. Joining me today to offer some perspective is Robert Kelley, the Editor of Elliot Wave International's U.S. Stocks Intraday Pro-Service. Hi, Robert. Thanks for joining me today.

Robert Kelley: Hi, Alex. Good to talk to you again.

AL: Now, you argue that the bull market is still ongoing, that this downside is corrective. Is that still your base case?

RK: Definitely. The wave count simply does not appear to be complete on a larger scale. There's a question short-term if this pullback has a little bit more to go or not. I tend to think not. But there needs to be a wave four, minor wave four correction and then a wave five to new highs before the bull market ends in my opinion. So that's going to take several months at least.

AL: Now, Robert, as always, I want to ask you about sentiment. You seemed to imply recently that it was leaning bearishly. If so, does that affect your bullish view at all?

RK: Yes, it supports the idea that the market is probably going to go higher most likely from current levels. And couple of sentiment indicators I follow closely are the CBOE put/call ratio. And it hit, as of Monday's close, the highest reading since early April after kind of a decent little pullback occurred. So option traders have been betting on the downside by buying puts. That's a positive implication for the market. And another indicator I follow is the CNN Fear and Greed index, which on August 18th hit 14. And that tied the low reading in early November last year right before the market lifted off. So these two very reliable indicators are saying that, probably, traders are too bearish right now. And that would set the stage for a rally from here.

AL: Now, Robert, talk to me about sector rotation. Is that an indicator that you follow? If so, is it a reliable way to spot tops and bottoms?

RK: It's definitely helpful. When you have - if every sector is going up and making new highs at the same time, that's usually a move that is not over or ending. But when you see certain sectors top out and maybe have a decline or go sideways for several months while the broad averages go higher, that's a sign that the internals of the stock market are weakening. It's hard to use it for a short-term timing tool. But from a macro- perspective, it's a warning that the larger bull market is approaching and nearing an end on a big picture basis.

AL: Now, I noticed that you believe that many of the ETFs you follow are tracing out very different trajectories. Is this typical of a correction or typical of a larger potential trend change?

RK: I do think it's sort of a rolling over process. And it is, I would use the word, process, because it's not an instant event. It takes-- occurs over many months, basically. So for example, the real estate and energy sectors topped out several months ago. In the case of energy, it's been in a nice downtrend for some time. So that's an initial sign that the some of the underpinnings of the market are weakening. But I can see some further strength to come probably in the tech sector, utilities, and biotech. So those may be the sectors that kind of keep the market heading up in the later stages of this bull market. So yeah, we're definitely seeing different sectors go in different directions. And that's an early warning sign that the rally is probably not going to last that much longer.

AL: Now, Robert, you've been in the markets for a long time. In your experience, have you seen this type of rotation occur often?

RK: I wouldn't say often but kind of approaching and near tops or bottoms when you see a big divergence. And frankly, it's not just a sector per se. But you can look at indexes like the Russell 2000, where you have different market capitalizations. In the case of the Russell, it's low market cap. For example, that's that stock index has topped and been going down for a little while. And I like to look for divergences. When I've got a completing wave count, let's say in the S&P or the Dow and making new highs, and the Russell is making a lower high, that just supports the view that probably, the larger rally is ending. So yeah, it's good to look at a lot of different sectors, a lot of different indexes. They can definitely hold clues for timing trend changes.

AL: Well, Robert, it sounds like there's a lot of important indicators to keep our eye on right now. Thanks for offering your perspective.

RK: There certainly is, Alex. Thanks very much. Talk to you later.

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