MIAMI, Fla. (MarketWatch) — Do we dare call this a bull market? The indicators were on target in January, and showed that the market had enough strength to go higher. Nevertheless, we’ll turn to the indicators to warn of potential dangers.
On the technical side, the Standard & Poor’s 500-stock index (SNC:SPX) is well above its moving averages, which indicate the bullish trend will continue. Obviously, a so-called Black Swan event can occur at any time, but after four years, we’re still waiting. The higher the market goes, the louder the crash warnings will get. But the market keeps advancing. MACD is also signaling that the upward trend will continue.
Meanwhile, the Relative Strength Index is signaling the market is overbought, which is a concern. However, the market can remain overbought for weeks or months before reversing.
Sentiment indicators, which tell you if investors are overly bullish or bearish, show that investors are becoming more enthusiastic about the market. The recent 0.67 put/call ratio hints that options investors are still bullish (and buying more call options). It wouldn’t be surprising to see the market have a short-term pullback, bringing investors back to reality.
CANSLIM sizes up stocks
Recently I had a talk with Amy Smith, author of How to Make Money in Stocks Success Stories , and an expert on the CANSLIM investment philosophy. I wanted to confirm that CANSLIM was showing what I see: a bullish market with possible warning signs. CANSLIM, created by William O’Neil, looks at current earnings, annual earnings, new products and services, share supply and demand, leaders and laggards, institutional sponsorship, and market indexes to identify strong and weak stocks.
Smith says that the overall market is continuing to act well, noting that “the Nasdaq (NASDAQ:COMP) is holding in a tight range.”
Because we’re in earnings season, Smith wants to know if institutions are starting to sell stocks, which would be a warning sign. If there is heavy selling, that would indicate mutual fund companies and other large players have lost faith in the market. Fortunately, Smith doesn’t see that yet.
Most important to CANSLIM, the leading stocks are still acting well, and so far there haven’t been major problems. Even though a few stocks (such as Apple Inc. (NASDAQ:AAPL) ) have had disappointing earnings, Smith says that happens every earnings season. Overall, according to CANSLIM, the market is acting strong but Smith is looking for signs of distribution (selling). The leading stocks are holding up, but she is watching them closely.
Can-do stock
When I asked Smith for a leading stock that fits the CANSLIM criteria, she mentioned Lumber Liquidators Holdings Inc. (NYSE:LL) , a retailer that provides hardwood flooring and lamination at discounted prices.
The company has profited along with the housing market recovery, and has a chart that any long-term investor (or covered call writer) might appreciate. Lumber Liquidators reports earnings on February 20.
Here’s why Smith likes Lumber Liquidators: “A lot of homebuilders are reporting earnings, which will tell us if the housing boom is continuing, or if there will be a slowdown from that group. Lumber Liquidators is a stock that has done well, and since October has been consolidating (a period of indecision). When they report earnings, we want to see if they can come out of this price consolidation on heavy volume.”
If the stock breaks out on strong volume, it would indicate that institutions are aggressively buying.
Strategic moves
Because it is earnings season, the market may be volatile in the short term. Nevertheless, the indicators are generally positive, and unless there are unexpected surprises, February could be a good month.
Rather than get swayed by fear, rely on fundamental or technical analysis, or a method such as CANSLIM. If you do see danger signs, then sell or reduce your position. But staying out of the market permanently because the markets might crash is not an investment strategy.
Michael Sincere www.michaelsincere.com is the author of “All About Market Indicators,” “Understanding Options,” and “Understanding Stocks.”
