Equities no longer have a solid wall of worry to climb upon....from an intermediate term standpoint. The following reasons are why
1) Massive surge in bond yields. If you look at every IT top in the past 2 years you will see they coincided with a surge in bond yields (I discussed this in a previous post)
2) Investor sentiment as measured by Investor's Intelligence is now showing bulls outnumbering bears by 2:1. This is the highest ratio since November 2007. One major caveat: it is natural to see a surge of extreme optimism during the first rally of a new bull market (like in 2003) without any ensuing significant market downside.
3) VIX approaching mid 20s. Prior to the debacle we saw last year a VIX in the mid-low 20's often coincided with a ST peak. Mind you, we saw the VIX go below 20 for several years in the middle of this decade with no bearish implications. The VIX is still not quite at mid 20's yet but its getting close.
4) Bears are being weeded out and those that remain are at the point of maximum frustration. A lot of bears have been wiped out or crippled by this recent advance and those that remain are furious by the lack of any downside follow through. I noticed that FAZ is no longer the top ticker on stocktwits and the number of traders posting there has dwindled significantly. Most of these traders were shorting the rally day in and day out via FAZ in particular, getting burned over and over again. We are overdue for the market to give these starving bears a little morsel of food.
5) A less talked about (and therefore more effective) contrarian indicator is the ratio of NASDAQ volume vs. NYSE volume. This provides a ratio of speculative seeking activity vs. safety seeking. The higher the ratio the more "greedy" investors are. It has just recently surged to 2.1, and is now at the same levels seen at the prior IT peak in May 2008 and close to levels seen at the bull market peak in 2007.
6) About 56% of stocks in the S&P are trading above their 200 DMA and about 90% are trading above their 50 DMA...similar readings reached at the peak of May of last year.
7) Mutual fund inflows are surging....a bearish contrarian sign. I read an article the other day which said that inflows to emerging market funds recorded a massive surge (over a span of weeks) which rivaled the surge seen just before they made a major bull market top in 2007. It's not just emerging market funds that are showing strong inflows...equities in general are too.
So, does this mean the big bad bear is coming back? Maybe, but my gut says we will just see a tease to the downside for now. I think for now what we could see is decent correction of 5-7% at least. But I think there's a good chance it could begin somewhere above the 950 level. Whatever remaining bears are out there are hanging by their finger nails. I'm quite sure if we break 950 it would cause them to capitulate and retreat to the SPX 1000 level to try and short it again. A break out above 950 would also likely cause capitulation from underperforming long managers who have until the end of the month to show quarterly results.
The bottom line is be very careful now with your long positions. One final surge is still possible here but it would likely result in a false breakout. This rally is now 3 months old and even if this is a new bull market, the initial bull rally off the bottom tends to last for about 3-4 months before a consolidation/correction ensues. More importantly, the favorable sentiment conditions for a further advance have largely deteriorated, in particular, the surge in bond yields and mutual fund inflows which have always been reliable rally stoppers in the past.
I will be on the looking to play the bear side on an IT basis in the coming days/weeks. The next couple of days are tricky because the market is at about neutral levels in the ST, hence, givining it room to make that one last surge.
By the way, I found out the name of that speculator I was talking about the other day. His name is Bernard Baruch and here's that famous quote I mentioned:
"The main purpose of the stock market is to make fools of as many men as possible"
Ain't that the truth? In fact, I am putting this line on my blog header as a constant reminder.
Here's a link to all of Baruch's quotes
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