Mid-week market update: As the major market averages make new all-time highs, I conducted an informal and unscientific Twitter poll. I was surprised to see how bullish respondents were.
Let’s just cut to the chase – forget it. Neither the fundamental nor the technical backdrop is ready for an advance of that magnitude. Even though the earnings and sales beat rates for Q4 earnings season is roughly in line with historical averages, Factset reports that the 12-month forward EPS growth is stalling. Past episodes has seen stock price struggle to make significant advances under such conditions.
In addition, the technical condition of the market shows that it is vulnerable to a pullback.
This rally has raised a number of red flags. Schaeffer’s Research pointed out that the advance has been accomplished on deteriorating breadth, as measured by 52-week new highs.
If history is any guide, expect subpar returns pattern for the next couple of weeks.
Independent of the analysis from Schaeffer`s, this chart from Trade Followers shows that bullish Twitter breadth is also not advancing even as the market made new highs, indicating a different form of negative breadth divergence.
Sentiment too bullish
In addition, there are numerous instances of excessively bullish sentiment, which is contrarian bearish. The CNN Money Fear and Greed Index is at a level where stock prices have shown difficulty rising in the past.
The CBOE put/call ratio has fallen to levels that can only be described as giddy. Urban Carmel observed that short-term returns tend to be negative after such readings.
The option market is flashing other anomalous signals. Even as stocks rose today, both the VIX Index rose and the VIX term structure, as measured by the VIX/VXV ratio, flattened. Such behavior by the VIX are normally signs of rising caution. I did a study that went back to November 2007, when data for the VXV was first available. I found 117 non-overlapping similar instances. As the table below shows, historical returns were disappointing for the following week.
As stock prices have risen, it is no surprise that most overbought/oversold models are showing overbought readings. Consider, for example, this chart from Index Indicators of the 5-day RSI above 70, which is a short-term (1-2 day) trading model
This chart of net stocks at 20 day highs-lows, which is a model with a longer term (1-2 week) time horizon, is also in overbought territory.
Overbought readings like those are to be expected as the market advances. There is nothing that says overbought markets can’t stay overbought. However, an alert reading sent me the following chart, which showed that the NASDAQ 100 is reaching overbought levels not seen since 1999, which was the top of the Tech Bubble.
Don’t get too bearish
Despite the combination of overbought and excessively bullish sentiment readings, my inner trader is not wildly bearish. Anecdotal evidence from independent sources of discussions with investment managers indicate that there is a lot of nervousness beneath the surface. This suggests to me that while stock prices may pull back in the near-term, any correction is likely to be shallow and should be bought.
Be cautious, but don’t go overboard on your short positions. My inner trader remains in cash and he is inclined to stay on the sidelines, for now.
6 thoughts on “Why the S&P 500 won’t get to 2400 (in this rally)”
I totally agree,I feel it in my bones&thanks for quantifying.i feel unable to get long& too anxious about getting short,so I am selling OTM call spreads & OTM calls in my long term investment portfolio.
When investors feel trading pressure it is likely because they are not following Cam’s policy of having three baskets of investment monies, long term, medium term and short term.
When his long and medium term money are in the market when it is reaching new heights, one is participating in the gains. The short term trading is just an effort to capitalize on short term swings and smooth out a bit the overall portfolio volatility.
If one has too much in the short term sector, it can distort ones judgement by putting too much pressure. It leads to swinging from FOMO, Fear Of Missing Out, one day and Panic about a big drop the next. One has to be a cool customer to trade effectively.
Cam has beautifully outlined and supported his longer term reasons for staying with that LT side of his portfolio which has done super. Because the short term gets more print day-to-day, we think that is larger than it is in his or his reader’s general financial plan.
Long term, we have a business friendly administration with a population experiencing a boost in consumer and business confidence. Until higher rates derail things for the economy and stock market valuation, we are likely in a bull market. So I wouldn’t be too worried about the longer term trend as far as a bear market starting soon.
As long as the market is going up, and it is going/trending up, I cannot go short — if I get too uncomfortable (like now), I do not add to long positions and I set tighter stops — if I get too nervous I get or stay out.
Speaking of getting bearish, I see Marc Faber is saying Donald Trump will be bad for US stocks (2017 and longer) and good for Asian stocks? What do you think of this Cam for the investor portion of a portfolio?
It depends on how the trade relationship is with China unfolds. If the US imposes tariffs on China, the Chinese economy will slow and it will wipe out economic growth in Asia.
Marc Faber has been bearish on the US market at least for the past five years or so and so has missed out on most of the bull market. His call on gold was made in year 2000 and he has been a proponent of gold since then despite a 40% loss in gold against the US $ since 2011. He has made calls for collapse of the US $ in the past five years that have also been incorrect so far. He is now making a case for emerging markets. I am not convinced how EMs would do well if the US $ continues to strengthen due to inward flows into US $ assets, protectionist tendencies under Trump like an import tax and squeeze on global $ supply. Furthermore, Cam has shown in the past few posts, $ outflows from China putting pressure on the Yuan depleting Chinese $ reserves below 3Trillon $. As protectionist tendencies rise their heads going forward, I remain perplexed how China and other EMs are going to keep growing as they remain heavily dependent on money flow from the west. Marc Faber is also in record that the US is going to require QE infinity to prop up the system. He has not been specific on the time frame of QE infinity either. Yes in our lifetime, there may be more QEs which is an attempt at boosting inflation. A protectionist US is going to hurt China and the US. China has banned Google and Facebook. Perhaps China will relax its trade policies based on pressure from Europe and US and if that were to happen, world would look different.
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