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Welcome to the New Year, and to the
“New Paradigm”, where stocks go up in perpetuity because, well,
because they’re going up, and because the Fed stands behind the market
likes a towering Father Christmas ready to pump more money whenever the
markets shows signs of flagging, and to maintain interest rates at zero
forever. It couldn’t look better, and therein lies
the problem.
I’ll tell you a little story. I was staying at
a hotel one night in Philadelphia, en route to Ithaca, NY, after a flight
from Germany, back in 2005. I couldn’t sleep so I switched on the telly and browsed the channels until I came across an
amusing infomercial by some dubious looking smooth talking guy going by the
name of Carlton Sheets. He had a small studio audience of
get rich quick wannabees assembled in a neat square
seating area that reminded me of a sheep pen. He was proceeding to give them
– and viewers – the benefit of his wisdom about how to make a
mint out of property speculation, and was talking about the leveraged buying
of entire blocks of properties. The only problem was that this was at about
the time the market peaked. The naïve greedy enthusiasm of the wannabees was palpable and they worshipped the ground
this guy moved over, but of course, they must have ended up being fleeced
when the property market crashed soon after. I tell you this little story
because this is exactly the atmosphere that we have surrounding the broad stockmarket right now – nothing can go wrong and
all you have to do is load up and enjoy the ride.
We have seen this “New Paradigm” stuff
over and over throughout history, but the most important thing you can learn
from history is that people don’t learn from history – you only
have to look at China and Japan squaring up for a war over a worthless group
of largely uninhabited little islands. Thus we had Professor Fisher in 1929
saying that the stockmarket would stay high for
ever just before the crash, the promoters of the NASDAQ tech bubble talking
the market higher just before it crashed spectacularly, the property market
con artists in the mid-2000’s etc. It never ends and never will until
the world runs out of greedy mugs – and it never will – and now
we have the stock pumpers.
Complacency is now rife. “Don’t fight
the Fed” is the mantra with the widespread belief that it is second
only to God in its all-pervasive power. So if the Fed says it will keep rates
at 0 until 2016, investors automatically believe it. The problem is that it
is not the Fed that ultimately determines the level of interest rates, it is
the markets. While bond holders are dull and unimaginative by nature, and
have the mental agility of a Brontosaurus, even they are beginning to get fed
up with the huge assumption being made by the Fed and other Central Banks
that they will be prepared to put up with any amount of abuse without
revolting. What is happening is that the Fed and other Central Banks are
debasing their respective currencies at a torrid rate with QE and other
dilution programs, so that bond holders, caught in a vice between inflation
and low or zero interest rates, are bleeding capital at a rapid rate. Even
factoring in that bond holders collectively are dull-witted and lethargic,
there has to be a limit to the abuse that even they will tolerate. What this
means is that eventually we can expect them to revolt in ever greater
numbers, leading to a snowballing downward spiral in bond prices, and an
accelerating ramp in interest rates, although they are now so low that it
will clearly take a while for rate rises to bite. This process has already
begun, with significant rate rises last year. Once they do bite, stockmarkets are likely to drop hard.
With many stockmarket
sentiment indicators now at outlandish extremes as we will soon see, the
situation is ripe for a “black swan” event to send markets
reeling. It is hard to say what catalyst will precipitate it. It could be
Thailand which is politically polarized and in danger of falling apart
economically and in danger of a civil war. It might not even require a
catalyst at all – all it would need is for selling to beget more
selling until a self-feeding cycle of liquidation develops. Let’s now
look at first at the chart for the S&P500 index, and then at a range of
indicators calling for, at the very least, a significant correction soon.
At first sight the 5-year chart for the S&P500
index looks as solid as a rock. The market just keeps on going up and up,
climbing the proverbial “wall of worry”, which is not so hard
with an obliging Fed pumping like crazy in the background to keep its pals on
Wall St happy, but once you start putting trend lines on the chart it starts
to look a lot more risky – and that’s before you take into account
the many indicators that are calling for a reversal or at least a severe
correction soon. The market has just hit a double trendline
target at the top of both an inner and outer bearish Rising Wedge. This just
by itself indicates that we are at a dangerous
juncture, especially given the steadily dwindling volume as this advance has
continued, which is a warning that the internals of this market are weak. On
the other hand, if the parabolic uptrend in force from the mid-2010 low can
succeed in forcing a breakout above the resistance of the upper trendline, we could see a final meltup
move that would suck in Mom and Pop big time who would mortgage the kitchen
sink to get in on the action. So let’s see what happens here – we
are certainly at an important juncture. Market technicals
and sentiment indicators are suggesting the former outcome – that the
market will not get above the upper trendline and
will turn tail and drop away now, or very soon. One thing for sure and that
is that you don’t want to be long this market if the lower supporting trendline of the channels shown fails, as if it does the
market is likely to drop like a rock.
The Smart Money – Dumb Money confidence spread is at an extraordinary
extreme, and I know quite a few dummies myself who think the market is now an
easy gravy train to riches and are heavily committed. They are not interested
in counter arguments, and have no time for abstract things like sentiment
indicators – if you challenge them they will quote things they have
read or heard on Bloomberg or CNBC to support their views. You
shouldn’t waste your energy trying to save them – let the market
teach them a lesson.
Chart courtesy of www.sentimentrader.com
As we can see on the Smart – Dumb confidence spread chart going back
some years, a big gap doesn’t necessary mean that the market will
reverse immediately – it didn’t in 2010 when the gap was high, so
it needs to be used in conjunction with other indicators. However, a big gap
certainly does mean that the risk of reversal is high.
 
Chart courtesy of www.sentimentrader.com
The number of indicators at extremes is now getting into the stratosphere,
and is screaming a warning to get out while the getting’s good,
especially as by getting out now you can pocket virtually all of the gains
resulting from the delusional Santa Claus rally.
Chart courtesy of www.sentimentrader.com
The percentage of indicators at extremes is also screaming a similar warning.
Chart courtesy of www.sentimentrader.com
The following indicator scores and groups charts paint a similar picture.
These show in particular that all the cash that can go into the market is
already in, although perhaps Mom and Pop can work up a little more cash to play
the markets by maxing out their credit cards, and that the dumb Rydex traders are fully committed and have their heads
squarely in the noose – all the market has to do now is kick away the
chair and they will swing.
Chart courtesy of www.sentimentrader.com
The stock and sector sentiment gauges are very interesting indeed, because
they show us what sectors to short, if we are so inclined. We can see that
the best sectors to short are Basic Materials, Financials, Housing, and
Industrials. Housing is for sure a good play for the downside, as the sector
will get slammed when rate rises accelerate. On the other side of the coin
the best sector of all to play on the long side, by a country mile, is the
often contra-cyclical gold stock sector, which Dumb Money won’t touch
with a 10 foot pole. It’s time to wade in and buy the better stocks
across the sector heavily, and we have already started doing it.
Chart courtesy of www.sentimentrader.com
The following chart gives the most graphic indication possible that the
market is ripe to reverse immediately or very soon. This chart requires no
explanation and you would have to be as dumb as an ox to remain staunchly
bullish after examining this chart.
Chart courtesy of www.sentimentrader.com
Finally the NDX Commercial hedger combo chart shows that Big Money is
expecting trouble – and positioned to make one helluva lot of money out
of it when it finally shows up.
Chart courtesy of www.sentimentrader.com
Conclusion – while the possibility exists
of a final vertical meltup blowoff
move, investors in the broad stockmarket should
maintain awareness that this bullmarket is getting
“long in the tooth” after almost 5 years of gains, and that risk
is at generally unacceptable extreme levels. It is considered prudent to
either sell existing holdings into strength or upon clear failure of the
uptrend line shown on our 5-year chart for the S&P500 index. The proceeds
may be invested in the now far safer and contra-cyclical Precious Metals
sector, which is viewed as being in the late stages of a bottoming process,
and where there are outstanding bargains to be had.
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