BE CAUTIOUS!!

It is time to be cautious! As I expected in the past few weeks, I said the overall stock market should be doing well in the seasonally bullish April. Indeed up until now it has been doing reasonably well. While I think this 6 years uninterrupted bull market still has some time to go, I’m increasingly convinced that there is a severe correction looming and may start in May. Corrections in the stock market is natural and healthy as it can shake out weak hands and allow the market to get sufficient energy to move further up. Prior to 2011, the market usually experienced 1-2 corrections of 10% or more. But we haven’t seen such kind of severe corrections in the past 4 years. As you can see in the chart, S&P 500 has kept moving up non-stop with a rising-wedge formulation but accompanied by a negative momentum divergence in the past 2 years.

Another concerning negative indicator is the lagging performance of the financial sector in the past one month (see the comparison of S&P500 vs XLF for financials). Actually more worrisome is the fact that XLF seems breaking down through its 50 moving average, which, if continues, will become a bearish trend for the financial sector. Without the financials to join, the overall stock market usually lacks of power to move up further. The latest change of behaviors of the market seem to also tell us something worrisome: in the past few days, S&P often opened high and strong but gave up most towards the end of the day, especially during the last hour of trading. This by itself is rather bearish. And now we are moving into the seasonally bearish May.  Putting all together, I think we need to be very cautious now and it is not a good time to blindly buy stocks now. Watch for the support line of the wedge around 2070. If S&P breaks below this level, it is likely to test its last Oct’s low at about 1860. This is little bit over 10% correction. We have to see by then whether it can hold up that level and what is the sentiment. It could be a great buying opportunity or the market may go down further before turning around. Let’s don’t worry about that for now but worry for the more imminent correction first. So what to do for this likely correction? I’m not suggesting to sell everything at the moment but at least be careful with adding long exposure at this point. Also tighten up your stop loss for your existing positions. You may also consider to buy some VXX to hedge. This is especially important if S&P dose breaks down through 2070, a strong indicator that it will significantly plummet from there!