SPY becomes short-term overbought

Stocks surged with a better-than-expected employment report on Friday. The Russell 2000, S&P 500 Equal-Weight Index, Nasdaq 100 Equal-weight Index and S&P 400 MidCap Index all recorded new 52-week highs. The Nasdaq 100, Dow and S&P 500 also surged, but remain just below their January highs. Small-caps are clearly leading the way higher here. Large-caps are lagging. Think of this as a Dow Theory style non-confirmation. Ideally, all of the major indices would record new 52-week highs within a week or two of each other. With the large-cap indices still below their January highs, I will be watching for confirmation in the coming days. Continued non-confirmation from the large-caps indices would be negative.

While small-cap leadership is generally bullish and shows an increase in risk appetite, it also reflects an increase in bullish sentiment. This is confirmed by Mark Hulbert of CBSMarketWatch.com:

Based on the several hundred investment advisers I track, I'd have to say that bullish sentiment is approaching dangerously high levels. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI), which represents the average recommended stock market exposure among a subset of short term stock market timers tracked by the Hulbert Financial Digest. It currently stands at 62.8%, up from 13.8% just one month ago. That's an awfully big jump for so short a period of time, especially considering that the Dow Jones Industrial Average rose a modest 4.4% over this period. Also worrying is that, with but one exception, the HSNSI is now at its highest level since early 2007, more than three years ago. That one exception, when the HSNSI was higher than it is now, came in early January, two months ago. Soon thereafter, of course, the market entered into its January-February correction, during which the Dow declined by nearly 8%.

Sentiment indicators are hard to use for timing. Excessive bullishness warns that the stock market may be getting too frothy, but we need to use the charts for actual signals. Last week, SPY gapped up three times: Monday, Tuesday, Friday. All three gaps held, which is impressive. The ability to hold these gaps shows strength, not weakness. Look for a move below 112 to fill the last two gaps. Key support remains at 109 for now.