When the stocks that institutions buy keep getting slammed back and forth without a positive trend, the institutions finally lose interest and start moving money to cash or the treasuries. Big bar swings are not healthy for bull markets. When volatility remains high for an extended period, it discourages investment. Historically, volatility increases when interest rates move too high (5 %+) or climb up too fast. Treasuries with increasing yields provide a safer bet when that happens. But even with historically low rates right now, sustained and rising volatility creates a destructive investing environment, and markets are struggling.
Impressive rallies such as the one last Thursday posting a 1.7% gain on SPY, and even finishing above its 5 DMA for the day, does not seem real because intermediate cycles are clearly heading down. You may also have noticed how the rally faded late in the session and the S&P 500 barely held on to its 5 DMA while the NASDAQ actually dropped below its own 5 day moving average at the close.
The initial powerful rallies must happen above the 5 DMA and then it becomes the support line for the ensuing rally. Anything else is typically a head fake – a profit taking rally by short sellers who are doing some covering – but not fully capitulating.
It seems that the strength of any recent rally these days is likely to be damped by the falling long-term cycle. Never bet the farm because stocks are cheaper or the high yield bonds are down. The junk bond market is taking a serious beating and JNK, the most highly traded ETF for that market, has lost more than 17% during the last 10 months.
At this point it is not yet safe to short the large market because the fall has happened so quickly. One has to keep in mind that bear market formation is a process and not an event. In order to take long positions we need a trigger for a massive buy back so that short sellers become convinced their positions are in jeopardy. That always happens when the rally spikes and stays above the indices 5 and 10 day moving averages. Panic buying by short sellers causes more buying and creates a surge in the overall market. However, the rally will likely be short lived.