Major US equity indexes all entered in all-time high territory last year. That in itself was a very bullish indication, as it showed the past of least resistance still remains to the upside. Last month, everyone on twitter, financial newspapers, market news websites was celebrating the fifth year anniversary of the current bull market, and let’s face it, market sentiment seems very bullish today… maybe too complacent?
To answer this question, let’s review some of the technical, internal and sentimental perspectives of the current bull market...
I first want to tackle the "too complacent" argument that a lot of market commentators - mainly from the contrarian or perma-bear category (think ZeroHedge) - bring to the table since early 2013 to predict the theoretical impending stock market crash. Even if the argument can seem logical, orderflow traders understand that a very bullish sentiment is not enough to predict a market down turn, even less a market crash. “The Market can stay irrational longer than you can stay solvent” as John Maynard Keynes is known to comment. I agree that sentiment extremes are important warning signal for traders. What many contrarians fail to understand is without any catalyst or reason for the sentiment state to be shaken, the turn will never happen by and of itself.
That’s the reason why many missed the 2013 rally, afraid by the extreme bullish sentiment signals provided by indicators like NAAIM & AAII surveys*. Take a look at the three failed sell signals in the chart below (blue circles). Those contrarians were blind to the major sentiment driver that was QE3, which along precedent FED monetary stimulus launch (QE1, QE2, OT), was a strong bullish signal for risky assets. As the old Wall Street adage goes: “Never fight the FED”.
Then, let’s now review the other sell signals, the two most successful ones. It is important to note that they both coincided with “changes in the rules of the game” (George Soros quote) via the end of QE1 in 2010 and QE2 in 2011. Those signals predicted the two major corrections (-17% and -19% respectively) of the current bull market. You will notice the similarity with current conditions where we will see the end of QE3 in the next few months (around September 2014 per consensus projections). Will history repeat or this time is different?
If you remember from my previous article on market cycles, seasonality is very challenging for stocks in 2014, and some other technical indicators are pointing out to weaknesses. For example, see the below S&P500 monthly chart. The RSI is showing a bearish divergence in overbought territory, a strong TA warning similar to what occurred at both 2001 and 2007 tops.
Looking at the shorter time frame, we can see one more bearish divergence on the daily RSI indicator as well as on the On-Balance-Volume (OBV). The price is building a rectangle consolidation pattern in a kind of rounding top, two well-known distribution chart patterns. This information, combined with confirming volume behaviour (increasing on down days) and yesterday bearish close below the rectangle support and the 50 DMA are more technical damages that warn we are close to seeing a top.
Finally, an interesting phenomenon is happening in terms of sectors rotation. It is clear that market participants are turning to a less aggressive risk taking stance. Take a look at how money flows from risky cyclical stocks (XLY) into safer, more defensive sectors like utilities and consumer staples (XLP, XLU) in the chart below.
Seasonal, technical, internal and sentimental evidences are too many warnings for me not to turn more cautious.
Let me be clear here, I am a trend follower. As such, I will paraphrase the old Mr Patridge from "Reminiscence of a stock operator": Well, you know this is a bull market!
I am not saying we are seeing the final top of the current five years bull run. I have many reasons to think it is not (that goes from fundamental to market breadth analysis) and I will cover them in my next article, but the main one is I always assume a trend will continue until proven otherwise. Top and bottom picking is the game of uninformed, loosing traders, and I recommend to play the downside only after a Dow bear market signal. Furthermore, US equities is the best asset class performer and as such I strongly advise being exposed to it.
That being said I can easily see the market offer future buying opportunities at better prices for the many reasons presented above. An easing to the first obvious support zone near 1730 and maybe deeper into the very big support 1550 (old all-time high and 38% Fibonacci retracement of the current 2,5 years up-leg) will offer such opportunities.
That is why I would also advice in the meantime buying protection through the acquisition of puts. We all buy fire insurance and hope it is never needed. I’m suggesting the same today for your stock exposure.
*NAAIM member firms are asked to provide a number which represents their overall equity exposure at market close on a specific day each week. Responses are processed to provide the average short (or long) position of all NAAIM managers as a group. The responses can range from 200% fully leveraged short to 200% fully leveraged long position.
The AAII Sentiment Survey is a weekly survey of its members which asks if they are "Bullish," "Bearish," or "Neutral" on the stock market over the next six months. AAII first conducted this survey in 1987 via standard mail. In 2000, the survey was moved to AAII's website.
RPS: Sell signals are generated when the two surveys indicate complacency.
The AAII Sentiment Survey is a weekly survey of its members which asks if they are "Bullish," "Bearish," or "Neutral" on the stock market over the next six months. AAII first conducted this survey in 1987 via standard mail. In 2000, the survey was moved to AAII's website.
RPS: Sell signals are generated when the two surveys indicate complacency.
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