The excuses for the May 6, 998-point meltdown were many: A clumsy, fat-fingered trader who entered a billion instead of a million sell-orders, lack of communication between the exchanges and of course, Europe’s sovereign debt crisis. However, the initial scare was quickly erased by a rally that started the same day and continued on Monday, May 10. In fact, that Monday saw the third largest S&P (SNP: ^GSPC) gap up opening in history. Not only that, the Dow (DJI: ^DJI) added 405 points that day. On Friday, May 14, the ETF Profit Strategy warned of the following: “Monday’s (5-10-10) trading session added another 405-point bounce to Thursday’s rebound. At first glance this seems bullish. But history tells us its not. We’ve found 16 instances where the Dow rallied 400 points or more, 12 of them hit during the post-2007 decline, most of them in September and October 2008.” What would be the initial downside target? The ETF Profit Strategy Newsletter continues (on 5-14-10): “Prices should now work their way below Thursday’s (5-6-10) intraday low of S&P 1,066 and Dow 9,787.” Slicing right through the 200-day MA Before prices fall that low, they’ll have to cross the 200-day moving average. That happened today. The 200-day MA sat at 1,102.56 for the S&P and it effortlessly cut through it like a hot knife through butter.  Regardless of how much significance you place on the validity of the 200-day MA average, the fact is that a lot of disciplined institutional investors base their decision purely on technicals like the 200-day MA. Once the indexes fall below the 200-day MA, an automatic sell order is triggered, compounding the further selling pressure. The S&P (NYSEArca: SPY) isn’t the only index that did or is about to break through the 200-day MA. The Dow (NYSEArca: DIA) is already trading below it and so is the Select Sector Financial SPDRs (NYSEArca: XLF). Goldman Sachs is $30 below its 200-day MA. The Technology Select Sectors SPDRs (NYSEArca: XLK) are significantly below and the Nasdaq (Nasdaq: ^IXIC) has already poked below it. More than just MA Moving averages aren’t the only indicators investors should keep on their radar. On April 28, two days after the S&P reached its recovery high of 1,219 the ETF Profit Strategy Newsletter noted: “With various sentiment gauges having reached multi-year extremes and Investors Intelligence bullishness at 54% (highest since December 2007), the potential exists that Monday’s high – which was only one point short of the 61.8% Fibonacci retracement at 1,220 – market a significant top.”
Sentiment readings and Fibonacci retracement level are important tools to keep in your investment tool belt. Extreme bullishness is usually an indication that a top is in place and a trend reversal is near. Why?  Bullishness correlates directly with available buyers. The more bullish the investing masses are, the more buyers of stock have already turned into owners of stock. Once the pipeline of buyers is depleted, there isn’t enough “ammunition” to drive up stock prices. All a stock owner can do is sell, which eventually drives down stock prices.
Virtually all sentiment measures out there registered sell signals end of April. The VIX (Chicago Options: ^VIX) had bottomed at 15.32, the lowest level since July 2007. The CBOE Equity Put/Call Ratio had dropped to 0.32, the lowest level in nearly a decade. The list goes on, but the core message was summarized simply by the ETF Profit Strategy Newsletter on April 16: “The message conveyed by the composite of bullishness is unmistakably bearish.” Since then, the major indexes have lost over 10%. The biggest loss in over a year. By the way, a similar theme has also developed with gold (NYSEArca: GLD) and silver (NYSEArca: SLV). Over 90% of all traders were bullish the precious metals. That’s never a bullish sign for prices. What’s next – correction or meltdown? The key question for investors often is: When is the time to sell? Will there be another rally that presents better sales prices or is waiting just compounding the problem with more and more losses to come? In other words, what’s the longer-term picture? The interaction between supply and demand is what prices in general as well as stock prices. As long as demand is there, prices will go up. Once demand dries up, prices will go down. Valuation and perception is what drives demand. Let’s take a look at a simplistic but telling illustration. Imagine you are auctioning off one of your old putters. The initial bid price is $100. There are no bids until finally one bidder gets the snowball rolling. Dozens of bids later, your putter sells for $200, twice the amount you were hoping to get. Your golf bag is now one putter lighter but your wallet $200 richer. Of course you don’t worry about that, but the new owner should ask the following: 1) Why didn’t anyone buy the putter at $100? 2) How much could I sell the putter for, is it worth $200? Dow 7,000 vs. Dow 11,000 The putter scenario describes what happened to investors over the past year or so. In March 2009, hardly anyone was willing to buy the Dow at 7,000. A year later, investors couldn’t wait to buy the Dow at 10,000 or 11,000. Absurd isn’t it? Investors who now own the Dow (the equivalent to the $200 putter) need to ask themselves; how much is it worth? The easiest way to attain stocks real value is to look at two simple but commonly used indicators – P/E ratios and dividend yields. When you plot historic P/E ratios and dividend yields against stock prices, you’ll see a direct correlation between the valuation metrics and major stock market tops and bottoms. At the tops, P/E ratios are high and dividend yields are low. The opposite is true at bottoms; low P/E ratios and high dividend yields. Just a few months ago, P/E ratios reached an all-time high of 122 (based on actual reported earnings as per Standard & Poor’s). The historic norm is between 15 and 20. The level reached at market bottoms is much lower. In other words, P/E ratios have much room to drop before they signal a major market bottom. The same is true for dividend yields. At a historically low yield of around 2%, stocks are far away from the often double-digit yields seen at major market bottoms. The message conveyed by valuations is deeply bearish. Just as ice doesn’t thaw unless the temperature rise above 32 degrees, the market doesn’t bottom until dividend yields rise towards the double-digits. Not only has the S&P (NYSEArca: IVV) dropped below its 200-day MA, the message from a composite of indicators confirms lower prices ahead. Don’t get stuck with a $200 putter. http://www.etfguide.com/ | 
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