2 highly regarded bears doubling down

I mentioned in my long winded rant the other day that 2 people that I read weekly, John Hussman and John Mauldin have failed to give a mea culpa about being wrong about the sustainability of the rally that we've seen thus far since March. Instead, they have been using the "is hasn't happened yet" defense with respect to their bearish predictions that have been wrong. This weekend I have noticed that they have both "doubled down" with their bearish convictions. Mauldin is calling for a recession within the next 18 months and he seems quite gun-ho about it. Hussman also appears to share this view although he didn't say it outright. In regards to Hussman here's what he said in his owns words:

"we can no longer find a single historical instance where stocks were more overbought on the combination of short- and intermediate-term measures we respond to most strongly. Indeed, only one instance comes close, which is November 28, 1980. The market hasn't been this overbought since 1980 on both"

He doesn't mention specifically which short and IT measures he is referring to but he did mention shortly after the following:

"As for the present, we have rarely seen nearly 90% of stocks suspended above their 50- and 200-day moving averages for as sustained a period as we have now observed"

Therefore, I think it's reasonable to assume that the above are the ST and IT measures he's referring to.

In response to these notions I will say this....


1) There was indeed a time after 1980 when the market got similarly overbought for such a sustained period and that was early 2004 which was the end of the initial bull market thrust from the March 2003 bottom. From the beginning of January to about the beginning of March over 90% of stocks in the SPX traded above the 200DMA the entire time. What happened afterwards was a correction and then sideways action for about 6 months whereby the maximum drawdown from the highest point to the lowest point was 10%. After that it was onwards and upwards as the market went on to make new highs by the end of the year.

We've seen the SPX hit the 90% mark a few times recently but we haven't seen it trade constantly above it for 2 months yet like in early 2004, instead, just recently, it's been hitting this level and backing off then hitting it again. I think before any meaningful correction occurs we will see the SPX trade above the 90% level for at least 2 months just like in early 2004....maybe even longer given how insanely oversold the market got last year which leads me to my next point...

2) Using the same measures, the % of stocks trading above the 50 and 200 DMA the market hit absolutely insane oversold levels for a very extended period of time last year and so my response to Hussman is "what goes around comes around". Hussman considers the current reading extreme overbought but he doesn't take into account that for about 5 months - early October 2008 to the March lows of 2009, the % of stocks trading above the 200DMA (and even the 50 DMA) was well under 10%...on average it was only 5%!!! It got so extreme that I remember one day in November 0% of stocks were trading above the 200DMA, 50DMA and even 20DMA!!!! I don't think in my lifetime I will ever see that happen again. The market literally had no pulse....and yet still the bear market still managed to make another significant lower low. That folks is what you call extreme and what we have seen this year is simply the unwinding of perhaps the greatest oversold market in history. Therefore in light of this context, the market isn't as dangerously overbought as Hussman makes it seem. What this also suggests is that it shouldn't be surprising to see the market hit even greater extremes in overbought conditions, thus ultimately making new highs, before finally getting a meaningful correction (i.e. 10% or more).

Hussman also noted that on November 28, 1980 the market made an important top just as signs that the economy was rebounding out of the recession in a similar way we see now with news being "less bad" and upticks in capacity utilization and new orders. The economy subsequently stalled in 1981 and the dreaded double dip recession was confirmed by 1982. Hussman therefore implies (he didn't say it outright) that we could see a similar outcome. My response to that is this...the best economist in the world strongly disagrees and by that I'm referring to Mr. Yield Curve. At the market top on November 28, 1980 the yield curve was well inverted and once again as always correctly forecasted a recession within the next 12-24 months. This time around the yield curve is steeply slopped saying "no dice" to the possibility of a double dip. Now mind you, with 0% short rates it's impossible to get an inverted yield curve but I'd say long rates would have be at least close to the 2% range for the yield curve to be inverted in essence. As of now it's steeply slopped. By the way, I remember the same calls for a double dip in late 2003 by many economists...Stephen Roach in particular.

Having said all this, there are indeed short term dangers in the market. We are seeing the VIX collapse here and the 10DMA of the put/call ratio is very low. We are also approaching 1100-1120 level whereby there's a well known resistance level whereby I'm sure the technically inclined are going to attempt to short. Markets didn't sell on the news last week very much as I thought could happen but be on guard here.

I've been staying away for ST trading because of the gappy nature of this tape and lack of good edges. That's fine by me...I'll just keep doing what I've been doing...looking at charts of individual stocks and building positions accordingly. If the markets bounce and reach the 1100-1110 level and I see other certain things give me the green light I may hedge my long stock positions via cheep OTM December index puts. Thus far my longs haven't been correlating very much with the market day to day even though they've been in an uptrend. This is a bonus but I know this can change and so I won't get complacent… a hedge would be prudent if I see things line up.