Are we there yet?

Many pundits are calling for a ‘melt-up’ in US stocks because of the game-changing Trumpanomics about to be unleashed on the US economy.  And since the election, stocks have indeed shot higher in anticipation of the tax reduction/infrastructure spending that Trump has proposed.  Here is the Russell 2000 small-cap (high risk) index that shows the supercharged rocket post – November 8

Let’s analyse this chart because it shows several textbook features in terms of EWs and tramlines.

I have a superb upper trendline/tramline that contains several accurate touch points and hence is a reliable line of resistance – at least it was until the break above it a few days ago.   It is now support, according my my Tramline method.  The lower blue line is not a tramline because it has only one touch point – the other one is an overshoot of it (similar to that in the Dow chart below).

Also, the rally off the February low is not an impulsive five-wave affair because wave 4 overlaps wave 1.  It is more akin to a five wave continuation (see text, pp 38 – 39, 144 — 145).  This implies a rally to the 14,000 – 14,500 area at least.  Hmm.

Now let’s switch to the safe and sound Dow (30 of the largest US corporations).

Again, we have a similar five wave pattern that could be a continuation pattern  or an ending diagonal.  We have the same overshoot in wave 4 but here, the market has only made it to the upper trandline and lags the Russell.

But the lower blue line could be considered a quasi-tramline with the Prior Pivot Point (PPP).  That places the upper as a tramline and as such, is a solid line of resistance.  The market has just hit it, so could turn here to complete the rally.

And the complacency level is back to where it was pre-Trump as shown by VIX:

Remember, previous declines have started from these low levels, so it could happen this time as well.  The MACD is turning up and that could indicate a VIX rally lies ahead (stocks falling).

As for sentiment, the US mom & pops are finally finding religion and have suddenly turned bullish.  Here is a chart showing the  www.aaii.com bullish sentiment (green) since 2007:

Since about 2015, retail investors (the least sophisticated) have been disbelieving of the rally and stuck in neutral.  But last week, bullish reading has zoomed up to the 50% mark – the highest level in over two years.  Also, the bull/bear spread has just shot up to 20% and is at its highest level since last November.

So, with the Dow up by 3,500 points (or 22%) in a year, the small investor is suddenly jumping on board the train, having missed that part of the rally.  This is a sign that the rally may be coming to an end and is a potentially bearish sign.

But there are other potentially bearish signs out there.  Advance/decline ratios remain very weak for such a strong rally phase, and put/call ratios likewise remain weak.  In addition, DSI has finally jumped above the 50% bulls mark, after spending weeks under it.  This confirms the new-found bullishness of both retail an investors after a strong rally.

As we know from history, market highs always start from high bullish sentiment. and is a top requirement for a high to be formed. With the Russell 2000 having closed up on 15 of the last 15 days (which must be a record, surely), small cap valuations must be stretched to the limit – and has been achieved over such a short time-frame.

To sum up: on the bullish side, markets remain in a bull trend.  The five wave patterns (especially in the Russell) look like a continuation pattern with an upside target in the 14,000 to 14,500 zone.  And bullish sentiment, although it has moved up recently, is not in what I would call at an extreme and there is room for more if the rally wishes to continue.

On the bearish side, internals are weak with only a few shares pushing the averages up.  The VIX Fear Index shows we are back in complacent times and at levels from where previous declines have started.  Also the Dow has just hit my upper tramline resistance and will need extra effort to push through.

Finally, here is latest COT for the Dow mini

and I confess I raised my eyebrows when I first checked it!  First, the trend-following hedgies cut their short bets in half that week as markets rallied hard post-Trump.  That, dear reader, is one huge change in sentiment and plays into the bullish surge story.  Now, they are 6:1 bullish – and I call that an extreme.  This short squeeze shows up really well in the Russell.

At the same time, the small trader remains disbelieving of the rally and shorted into it.  Then the commercials (smart money) likewise shorted into the rally and are now over 3:1 bearish.

This data tells me we are poised for at least a correction in the next day or so.

One final thought:  The stock market has bought into the Trump stimulus scenario lock, stock and barrel.  And so has the Treasury market.  The 30-yr bond fell from 164 pre-Trump to a recent 152 with the jump in yields as the bond vigilantes spied a massive increase in borrowing .

Of course, this yield melt-up has been matched in the corporate bond market where yields likewise have risen.  But because most of the funds so raised have gone into dividends and stock buy-backs, higher yields will put a crimp on such further activities and this will weigh on the stock rally.  How hard, we shall have to see.