Bulls Go to Extremes: Don't Buy the "Breakout", Sell It, Prechter Says

Stocks jumped Monday with the Dow rising 1.4% to 10,753 and the S&P gaining 1.5% to 1143, its highest close in four months.

The S&P eclipsing 1130 for the first time since late June would seem to confirm the long-awaited technical breakout for the index, and could pull many reluctant investors off the sidelines. "Many automatic buy and sell orders are set around market milestones such as these, and investors watch those levels closely for clues about which way the market may go next," the AP reports.

But the wise move now is to sell this recent rally, says Robert Prechter, president of Elliott Wave International.

"I think we're getting ready for another leg on the downside," Prechter says, citing evidence of what he says are extreme levels of optimism, including:

  • -- The most-recent AAII poll shows bearish sentiment at 24%, less than at the Dow's peak in October 2007.
  • Mutual fund cash positions being at record lows, which Prechter says should be taken at "face value" rather than the result of massive redemptions from equity mutual funds.
  • The TRIN Index (a breadth indicator) at one of its lowest levels in recent years, indicating extreme buying pressure of stocks at 52-week highs, i.e. investors chasing momentum/performance.

In addition, Prechter notes volume has been punk during the rally in recent weeks a sign, to him, that buyers lack conviction.

The veteran market-watcher says the current environment is similar to the 1930-31 period. "The market can make its high while optimism makes a peak despite the fact you're going stair-step lower," he says. "What we had in May with the ‘flash crash' was the first wave down."

Prechter predicts these periods of downturns sandwiched around 4-5 months of recovery "where people think we've hit the bottom" is likely to "go one for quite a long time" until a true bottom is reached well below the March 2009 lows, much less today's levels.

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