Note: This is part two of a two part write up re-visiting current equity market conditions. Part I is posted just below this article.
Come on... lets all be honest here, even the bulls are surprised by the current rally, at least a bit. I know I am. Look at that pop last night and the accompaning volume. Bears really got squeezed and they are squealing. Statistics state that this is currently the best month of gains Dow Jones has ever seen in its glorious history, while S&P 500 hasn't done this well in one month since the famous 1974 bottom. When was the last time in your lifetime you saw Dow Jones post the best monthly gain ever?
And what about deflation fears, European banking collapse, global recession and Chinese property collapse? Where are all those bears who constantly argue these things... including myself when it comes to China (hahaha) or that specific one guy who always posts links about global deflation on this blog? Looks like all of those worries are a perfect wall for the bulls to climb, so they will be put aside until some later date. In the meantime, even bears have being buying risk on assets or retreating back to their caves.
Introduction
Introduction
Do you remember the crash analogue I posted during August and September as the VIX spiked? It turned out the bottom was nailed perfectly around the same time that 1990 and 1998 bottoms occurred when looking at both percentage and time. As a matter of fact, majority of the bear markets or downtrends tend to bottom between 60 and 70 trading days after the VIX spikes to extreme levels. It turns out that time wise, this was a plain vanilla downtrend. So.... where to from here?
Short Term
From the short term technical point of view, S&P 500 is now trading 2 standard deviations away from its 50 day moving average. It is also near 200 MA as well as previous neckline resistance. The rally has moved about 17% to the upside, in about three or so weeks - a tad overdone from the short term, don't you think?
Breadth wise every single sector is now overbought from the short term perspective as well. Consider the following when we look at cyclical sectors with stocks above 10 MA and 50 MA:
- Discretionary: Above 10MA @ 94% & 50MA @ 97%
- Energy: Above 10MA @ 100% & 50MA @ 100%
- Financials: Above 10MA @ 100% & 50MA @ 100%
- Materials: Above 10MA @ 96% & 50MA @ 93%
- Industrials: Above 10MA @ 96% & 50MA @ 100%
- Technology: Above 10MA @ 92% & 50MA @ 95%
Definitely looks like the market needs to take a bit of a breather with a pullback, however one should also note that powerful breadth moves like these create continuos rallies - more on that later.
All of these signs signals that a pullback could now be in the cards and same is true with certain sentiment indicators. When I look at the Equity Put Call Ratio, it shows some signs for concern after such a powerful run up in the last 4 weeks. Retail investors are now loving equities, but that doesn't necessarily tell us that an immediate sell off is in the cards. It is just a cautious warning and something to keep in mind, not the chase the price with the rest of the crowd, but to wait for a pullback if you consider buying this rally.
Medium Term
Well, this rare occasion in the last 60 years, where the market fell 15% or more during the past six months, then rallied 15% or more during the current month. The other dates were October 1974, October 1998, October 2002, November 2008 and March 2009. All of these dates were major bottoms in some shape or form. Therefore, it will be a total surprise if this market just stops dead in its tracks right here, right now. History shows that these types of momentum moves follow through at least for awhile. Keep that mind, before you start screaming about how everyone is in complacency mode again. Also keep that in mind, if you are thinking of shorting this market again.
I discussed breadth from the short term perspective, however from a medium point of view, the current readings just hit a decade highs. Percentage of stocks above the 50 day MA within the S&P 500 just got to 94%! This type of price actions indicates that the whole market is now participating in this rally - a huge bonus for the bulls. From the positive view, we can also see that the bearish breadth divergence has finally been taken out. Another thing that the bulls will be glad to see as recently as last night, was that NYSE registered 173 52-Week New Highs vs. only 7 52-Week New Lows. This is the highest bullish breadth reading since July 2011.
I also mentioned some warning signs from the short term perspective when it comes to sentiment and the amount of calls currently being bought. Having said that, majority of the sentiment indicators still remain either very bearish or neutral at best. Short interest still remains high, cash levels by hedge funds according to Merrill Lynch Fund Managers Survey remains extremely high and deflationists are still in love with bonds. All in all, these signals are a wall of worry for the stock market. The chart above shows AAII, Investor Intelligence, Market Vane Sentiment and Consensus Survey together in one indicator. I placed a three month moving average on the readings and all I can say is... boy do investors hate stocks!
Long Term
After spelling all of this out for you, one should ask themselves, why didn't I participate after calling the bottom in early late September and early October? Well, for a decent rally, one would argue that I should have, but is this really a proper bottom? I will try and answer this from the business cycle perspective.
On top of the breadth readings above, we also registered a NYSE 90% upside day yesterday. That means more than 90% of the breadth and 90% of the volume was moving towards the upside. In the short term, this can signal a decent pullback in the cards, but from the medium term perspective, this type of price, breadth and volume action is quite positive as it shows strong commitment by the bulls. After so many 90% downside days during August and September (even into early October), it looks as if the bulls are now saying - we are finally in charge. Also to note is that as of last nights close S&P 500 is now up for year... fancy that!
After spelling all of this out for you, one should ask themselves, why didn't I participate after calling the bottom in early late September and early October? Well, for a decent rally, one would argue that I should have, but is this really a proper bottom? I will try and answer this from the business cycle perspective.
This was a very weak bear market from the historical point of view. That is probably because the business cycle did not turn down and a recession was escaped for now (I did argue this for majority of the 2011). A proper bear market, accompanied with a recession, usually sends the markets down between 30% to 40% and lasts for over a year. S&P 500 missed the bear market by a percent or two and corrected for only 5 months since it topped on 02nd of May this year.
One could argue that 1990 and 1998 bear markets were very similar and they produced very good returns afterwards. Here I would say, yes that is true, but both of those bear markets occurred during a secular bull market in equities, and currently we are in a secular bear market.
On top of that, while I think this business cycle has been very impressive with very strong earnings (this is where recession predictors should turn a red face), eventually all business cycles come to an end, margins starts contracting and earnings starts to disappoint.
I am not sure when this will happen, but usually it is safe to assume recessions in United States have come about every 4 to 6 years from historical perspective. Currently fundamentals are very weak, so it will probably be the earlier figure. That means if the last proper downturn occurred in 2008, we are overdue for a recession sometime between 2012/13 or maybe even earlier.
I am not sure when this will happen, but usually it is safe to assume recessions in United States have come about every 4 to 6 years from historical perspective. Currently fundamentals are very weak, so it will probably be the earlier figure. That means if the last proper downturn occurred in 2008, we are overdue for a recession sometime between 2012/13 or maybe even earlier.
Long term investors, like myself, tend not to buy and hold any assets with a large potation of capital unless they see earnings are depressed, assets are beaten down hard and recessions occur. Recessions clean out the system and create great buying opportunities that are self sustaining afterwards - in this months bottom, we didn't get that. So hopefully that answers your question. Traders on the other hand so be having a play day in this volatility, so knock yourself out.
Summary
Well basically, from the short term the market is over-stretched and one should be cautious buying stocks from here onwards. We have had a 4 to 5 week advance of 17%, so I would expect consolidations, pullbacks, whipsaws etc etc.
Some bears are still arguing this is now a new top. Squealing perma bears also argued this will be worse than 2008 and look where that got them! From the work I presented in the medium term, while anything can happen, I think we have bottomed for now. Strong breadth expansion indicates the whole market is participating, financials are now in a bull market outperforming the overall index (very positive leadership sign) and sentiment itself still remains cautious, giving bulls the wall of worry necessary for higher prices.
Does that means we are out of the woods now? I do not think we are at all. Europeans only really saved Greece. They didn't deal with other countries. And besides, the more bailouts Germany and Franc does, the worse position they put themselves in - so the whole thing is a disaster.
Eventually something bad will happen, so from the long term business cycle perspective, a recession is coming sooner or later. There will be pain. Expansionary business cycles last about 4 years in secular bear markets and by 2012, we are in the fourth year of this very weak expansion. I therefore expect more surprised as the market is bound by 1500 on the upside and about 1000 on the downside. Will stocks sink straight into a hole? No during secular bear markets, stocks move sideways, something bears constantly fail to understand!
Survey Poll
Finally, thanks to all who voted in last nights poll, it was a quick 24 hour turn around, which shows majority of you do not believe this is a new bull market.
Eventually something bad will happen, so from the long term business cycle perspective, a recession is coming sooner or later. There will be pain. Expansionary business cycles last about 4 years in secular bear markets and by 2012, we are in the fourth year of this very weak expansion. I therefore expect more surprised as the market is bound by 1500 on the upside and about 1000 on the downside. Will stocks sink straight into a hole? No during secular bear markets, stocks move sideways, something bears constantly fail to understand!
Survey Poll
Any thought on precious metals? Is the breakout likely to be a sustainable one?
ReplyDeleteI don't know. That is tough one.
ReplyDeleteI was very close to buying some Silver around $30, but I have a feeling both Gold and Silver are not yet at real bottom. In other words we might rally, but also come back again. Therefore I thought about it very hard but decided to still out. You shouldn't listen to my opinion anyways, I am just telling you what I am doing.
I could be completely wrong. It is just that optimism on Gold was and still is very high, everyone keeps saying Fed will print and keep rates at 0. When too many people say the same thing, no one is really doing any thinking. And Gold still to this day has not traded below its 200 MA for over 3 years now. Everyone keeps saying Gold will go higher technically, after it has been going up for 11 years in the row.
Throughout history I have never seen any asset do 11 years in the row of gains, so I am very skeptical. 12 years in the row? I doubt it... even Nasdaq during its huge run up bubble phase of late 80s and the whole 90s had down years, long periods of consolidations and corrections of 30% or so.
I forgot to add, instead of precious metals, I'm looking long at hard at buying Agriculture soon, maybe even today or next week if it sells off one more time...
ReplyDeleteThe reason I asked this question is because I have the exact same feeling of doubt as you have. Yet the voice of the crowd advocating gold and silver is so strong, it is tormenting to stay against the tide.
ReplyDeleteYeah I understand. Look, if it helps sentiment indicators on the Gold and Silver over the last few weeks have been extremely negative. Very bearish indeed, especially for Silver. Therefore, it should be no surprise that these assets are rallying hard right now.
ReplyDeleteBut I'm still not budging just yet. I prefer Agriculture relative to Metals. I mean Gold is up about 6 times over the last 10 years, Wheat or Soybeans are only up double or so. I would just like to see Gold have decent correction and shake out weak hands who bought in the last year or two, before I buy. That is not to say that Gold and Silver cannot go even higher now, but for me, Agriculture isn't overcrowd.
Good point.
ReplyDeleteI'm a bit confused by the summary:
ReplyDelete"Well basically, from the short term the market is over-stretched and one should be cautious buying stocks from here onwards."
with
"I think we have bottomed for now."
Why not buy if you think this is a bottom?
good post.
ReplyDeleteWe are in a wall of worry similar than summer of 2010.
hagen
To clarify your confusion... don't chase prices and buy now, wait for a pull back if you want to participate. We just had a 17% rally in three weeks. You should have already bought in late September and early October if that is what you were after.
ReplyDeleteI personally don't want to buy because the rally will be false, while it can still go higher. All stock market rallies are false, because stocks are in a sideways trading range since 2000. I want to stick to proper investments that in a secular bull market - that means buying commodities.
A nice head and shoulders pattern is forming on the FTSE 100 that starts in March 2009 - the rally of the last month is a rally of desperation clinging onto any good news IMPO.
ReplyDeleteThe Euro situation is not sorted by any means - it is not even clear if Greece has been bailed out let alone the rest of the PIIGS. It is only going to take some realisation, such as China saying no to helping out the Eurozone, or Italian bond yields soaring and you have your black swan that can retrace October's, and indeed last week's, surge.
October was supposed to be the bearish month - perhaps it will now be November?
Not that I am jealous - I am VERY jealous. Wish I had enjoyed the last month's climb in equities and silver. If I had then I would have been out on Friday. But the fundamentals are so poor that, as I said, people have clung desperately to any signs of good news and bought. Retail investors will now probably be lured in and creamed.
I think only one bit of bad news will cause these markets to tank. I think it will either be the reality dawning on people that the Eurozone is still in a mess or that great hope - China - just goes into melt-down.
I disagree to a certain extent Bob. First of all I do not think people bought cloning onto good news. Markets rallied because majority were short and clinging onto the repeat of 2008. And now majority of retail investors and professional are underinvested.
ReplyDeleteSentiment became very bearish that the market was ripe for a squeeze. The catalyst from the Eurozone leaders made the squeeze massive, which even I didn't expect. Did you know that we have already rallied 20% since the intra day lows of early October in just three weeks? That is officially a bull market threshold. However, if you look at the recent survey poll on my blog, you will notice that majority of readers do not believe it is a bull market.
I'm not sure who will be right or wrong, but I can tell you one thing... the only thing this market has going for it is that no one believes in it. And that is precisely what a wall of worry is all about!
You are probably right. I am just a poor retail investor scared stiff of inflation destroying my savings, but scared stiff of what I perceive to be heavily manipulated markets.
ReplyDeleteMy gut tells me that between now and Christmas it is going to become clear that the Euro mess is most certainly not sorted - at which point I expect the markets to tank and that 20% profit could be wiped out in a day or two.
Still wish I had bought, banked the profit and then be sat on the side-lines with that profit in cash. Oh well.