I half-jokingly posted the Barron’s 30,000 Dow cover as an example of the over-reaching and unrealistic manic bullishness of sections of the media towards the stock market – and total belief in the Trump Bump.  But last week’s strong performance has wiped a little of that smile off my face!  But not much because we are currently trading the long side.

Yes, both the Dow and S&P (and Nasdaq) posted new all-time highs yesterday.  But FTSE and DAX did not – and that reflects the Trump Bump that has been partly inspired by the President’s tax and spend plans which will benefit US companies rather than foreign ones.

One reason I generally prefer to trade the US stock indexes is that market data is much more readily available – and goes much deeper – than the others. Of course, I am referring to sentiment data – a vital component o f my analysis.

For the US markets, there is a plethora of this but a dearth in overseas markets, such as FTSE.  So let’s look at the current state of US market sentiment, which highlights the extreme bullishness out there – and highlights the extreme potential for a massive collapse.

Last time, I showed the chart of the AAII data:

chart courtesy www.elliottwave.com

This is a survey of professional advisors such as CFAs and futures fund managers and shows their near-record level of optimism that has morphed from their deep pessimism a year ago when the Dow was trading 5,000 points lower than today.

This one chart alone is a stark demonstration that along with mom & pop investors, the professionals also herd.  In fact, they not only herd but they en masse Buy High and Sell Low – and do the very opposite of Investment Golden Rule Number One!

It is deep within our nature to become excited by rising asset prices (the very opposite for rising consumer prices!) and there is nothing wrong (and everything to gain) with joining the herd if it is early in the game.  But when the herd size becomes totally dominant, this majority becomes convinced absolutely nothing can go wrong.  And that is when the savvy professional knows the game is about up and acts accordingly, leaving the majority holding on for even more gains, that never come.

And that fixed human trait – that has not changed since the dawn of the markets – is the one basic reason why savvy traders understand the message contained here, which is that the bull run is living on borrowed time.

Here is another sentiment measure – the cash holdings of fund managers.  When everyone loves stocks, the pressure is on the managers to go all in and leave only a little cash on hand.  If they are not fully invested in a rising market, their jobs may well be on the line. This is a form of herding, where safety lies in going along with everyone else.

chart courtesy www.elliottwave.com

Note how cash levels are high when shares are cheap and vice versa.  Another lesson here is that for almost 20 years, cash levels have been mostly under the 4% level, which is historically low.  This has been occurring at a time when stocks have been in a huge bull run.

And with cash-to-assets at a record low of 3%, there is surely little ammo to buy when stocks do correct and become cheaper.  So where is the ‘wall of money’ that many bulls believe will descend as if from heaven when companies repatriate the trillions held overseas in a possible deal over tax treatment?  Those lovely hoped-for dividends will be a one-off anyway – and will do nothing to boost Capex, which has been languishing for years.

As one other measure of extreme bullishness, the extremely high complacency towards a significant decline is contained in the VIX Fear Index  and its derivatives.  Here is VXX

For a year the level of fear has been dropping like a stone and in recent weeks, the slope has been turning much more vertical.  The extreme divergence from the 50-week and 200-week MAs must be at a record.  If  you believe in the reversion to the mean theory, the snap-back will be violent when it occurs.

And here is the Junk Bond Index, which is a measure of bullish sentiment towards the economy.

A rising index is a sign investors believe the yields are safe – and track stocks up and down, more or less.  But they are pulled the other way by yields in the Treasury and corporate bond markets which are in a medium-term downtrend.  So far, the bulls are winning but the market is in a final fifth wave which could turn at any time.  Note also the large mom div which signals the buying force is weakening.

And the turn should correspond to the next increase in Treasury yields which will be historic.

I mentioned the AAII Professional Advisors extreme bullish stance, but their clients – the mom & pop investors – are not buying it.  Here is the latest AAII sentiment survey of retail US investors:

These figures have been pretty consistent for weeks now and show the bullish cohort only tepidly so with current data slightly less than the historic average.  The bearish figure is slightly under the historic average, while the neutral cohort is above it.  This latter group is the interesting one because it shows the high level of suspicion surrounding the bull market.

And that has something to do with the caution on Main Street while Wall Street is still basking in the glow of the past and future government stimulus that has remained there.

Another factor is the ongoing switch into index funds and ETFs, rather than picking individual stocks.  There is a tidal wave of money going into these funds and out of  traditional funds – and that surely points to the failure of fund managers to add value as stock pickers.  In fact, their performance has consistently been underwhelming compared with the benchmark S&P index in recent years.

Putting all this together, I can only conclude that the stock market rally is very near the end of the road.  Because sentiment is at record extremes, I expect the decline to be historic.  A deflationary collapse awaits – but not quite yet.

We have a little more on the upside, I believe.  Here is my Best Guess for the Dow:

When this current rally turns, we will have a decline, then a rally to new high within a few weeks – and then THE TOP.

 

VIP TRADERS CLUB NEWS

My short trade the previous week failed – but since we moved Protective Stops to break even, no money was lost!  And that failure to break down was the heavy hint that the market wanted to move up – and we went long.

Yet another example of why I insist on using this Rule with discipline if trading success is desired!

I had noted the kiss on my trendline and if it went to plan, I expected a scalded cat bounce down.  But the decline was contained and that was my clue to expect a resumption of the rally.  Such flexibility is key to short term trading.

To learn more of how my VIP Traders Club works, go here.

 

VIP PRO SHARES NEWS

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Comment ( 1 )

  • Andy Franks

    I have sold my portfolio many times over previous years when you have anounced stock market falls of historic proportions

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