Still at least one more downside scare left

The market is in a strange place right now. On the one hand, there's plenty of indications that longer term, the market is in position to go substantially higher. Look at the move bonds have had both in the short and long term and how pitiful yields are on an absolute and relative basis (i.e. vs earnings yield of stocks), look at the behavior of long term equity fund flows, look at consumer sentiment, talk to your neighbors about how they feel about the economy and the stock market. All of the above suggests that pessimism is very high - that there's a lot of people on the sidelines, the same people whom by the way, are the dumb money by which history shows over and over are pessimistic/scared near major market lows and optimistic/greedy near major tops. But here's the thing though, these contrary indicators pertain to the long term - they will do you no good in timing the ST moves in the market. Which brings me to the ST/IT. I see some troubling signs.

First, I'm noticing the technically inclined types have turned bullish, you know, the ones that trade based upon momentum indicators, breakouts of "key resistance levels" or moving averages, ect. In the past 2 summers, I've seen such folks turn bullish after a bounce and it ended up marking a ST top or close to one. The "Rev Shark" over at realmoney.com for example is bullish.  These people are weak holders easily shaken out and so when you have a lot of these butt sniffer types long at the same time, the market is vulnerable to a sharp drop as they tend to stampede for the exits at the first hint of weakness. I'm not sure if Friday was the beginning of this stampede but I'm reasonably sure that you'll be able to buy the market at lower prices sometime in the next month or two. Confirming the anecdotal evidence I'm seeing is the latest reading from NAAIM which showed a jump in long exposure to 63%. That number is not alarming on an absolute basis but it's high enough to suggest the market is vulnerable to at least a significant pullback. Next you have the VIX. At 17, it's not exactly the most ideal time to be enthusiastic about the market if you look at recent history. What's more troubling is that the VIX actually closed in the red today despite the market weakness. That's a sign of complacency. Lastly, there was a spike in inflows this week to the same degree which shortly preceded the last ST peak in mid June.

The way the market has been trading reminds me a lot of the flash crash aftermath of 2010 and the period we're in right now reminds me of early August 2010 where the market was forming a ST peak and I noticed pretty much the same conditions.


There's obviously plenty of things that could happen to scare weak longs. The main thing I'd be concerned about are signs that economic weakness is gathering stream in the US. We saw the weakest ISM manufacturing index reading in 3 years registered last week coming in just under 50. Regardless, whatever the catalyst may be, the market is vulnerable in the ST because it's ST overbought and there's weak longs jumping in - a combination that seldom works well in the end.