Complacency Continues As Warnings Mount
Weekly Notes With Tiho — Issue 12
Location: Belgrade, Serbia
In the previous post, I discussed a few important topics.
Firstly, US Dollar became very oversold — with sentiment overly bearish. Since the greenback has managed to jump on a solid jobs report.
Let’s see if there will be a follow through this week.
Secondly, Gold’s technical coiling pattern. For now, indecision continues.
I am watching this one closely, as mentioned before. Strong Dollar is usually — but not always — negative for Gold.
Having said that, at times they were best of friends and rallied together.
And finally, stock markets complacency.
On Thursday, Dow Jones Industrial hit its 33rd record for the year — same as 1929.
On Friday, 34th record for the year — same as 2007.
And yesterday, 35th record for the year — same as 1999.
As I write this, we are watching yet another record high.
Dow Jones Industrial index is now up 10 days in the row.
Leading Sectors Are Underperforming
At the same time, there are fewer and fewer stocks rising. By and large, it’s the mega caps and quality stocks that seem to be pushing the indices up.
Russell 2000 small caps index is down over the last couple of weeks. Interestingly, it is trading around March 2017 level.
It is dramatically underperforming in 2017.
Furthermore, technology stocks aren’t leading anymore.
Nasdaq 100 is trading at levels last seen in June 2017, while the market darling — Semiconductor sector — is well below its June highs.
While these signs might just be pauses before the main trend resumes, there is no doubt that the trend is overextended.
The further it runs, the stronger the correction will be.
Correction Is Overdue
I am anticipating a correction.
And starting to position for it, too.
The stock market has now entered a weak season period of the year. This weakness usually — but not always — shows up when the uptrend tends to become technically overbought, the market sentiment very bullish and complacency widespread.
Over 18 months have now passed since a meaningful pullback.
That is the longest period during this bull market.
Looking back over the last 60 years, that is also one of the longest periods without even a 5% correction.
Twitter users who follow my account, should be able to recall various posts on the lack of volatility across asset classes. Bullish sentiment tends to go hand in hand with that kind of a condition.
Recent Investor Intelligence survey showed that the percentage of optimistic newsletter writers and advisors is one of the highest over the last two decades.
I’ve also tweeted about the fact that majority of market participants who have been short the market have covered their positions.
Finally, fund managers continue to hold high bullish exposure towards the stock market. At the same time, last week I discussed how retail investors are holding the lowest level of exposure towards cash since the year 2000.
Breadth Is Diverging With The Rally
Clearly, warning signs are mounting and the stock market breadth is also included on this list.
The key chart I have been closely monitoring is the percentage of S&P 500 components that are currently trading above their respective 50 day moving averages.
A negativly sloping red line indicates that stock market breadth has been in a continuous process of divergence with rising price.
In other words, as the rally progresses, fewer and fewer companies are trading above the 50-day MA.
Or better yet said — fewer are participating in the uptrend.
While initially, 90% of all S&P companies were trending in a bullish manner, this has been decreasing over time and now only about 70% of the companies are able to trade above this short term moving average.
At this rate to breadth deterioration, the index will eventually roll over and the correction should start.
The Scariest Chart In The Finance
The bond market is also sending us warning signals, too.
Credit spreads have narrowed dramatically over the last several quarters.
The spread between various quality bonds and the risk-free Treasury market is at one of the lowest levels since the bullish cycle started in early 2009.
Admittedly, it could go lower… similar to the 2003-07 cycle.
However, the scariest chart in the financial markets right now is European High Yield (junk bonds) relative to the yield of US Treasuries.
During times of panic, distress, and recession — the spread between two bond markets would rise over 10 percent and as high as 20 percent.
However, today we are far away from panic.
Today, we are in a period of euphoria, or at least the early stages of it.
As investors go “kookoo” for risk assets, they have pushed (with the help of ECB) the yield of European Junk Bonds towards that of the US Treasury yield.
Honestly… I’m speechless.
My clients are staying away from assets such as Eurozone High Yield bonds because I feel that we aren’t compensated enough for the level of risk one would undertake.
As a matter of fact, the majority of risky assets look as if they are priced for perfection in the short to medium term. Possibly even for the longer term, if one has read our valuation post.
However, let us remember that the warning signals aren’t predictors, nor do they have perfect track records. They are exactly what they are — warning signals.
Throughout market history, sometimes the market ignored these warnings and continued to march higher. At other times, major crashes surprised investors who did not heed the early warnings.
If you would like to know how I am positioning my client’s portfolios and how we are preparing for the potential correction ahead — get in contact by clicking below and filling out the brief survey.
I’ll get back to you within 24 hours.
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