Sentiment on Stocks and Ratio Charts

Below is a brief update of a few stock market related data points we frequently discuss in these pages. Sentiment on stocks continues to be a mirror image of the gold market. Investor complacency is quite pronounced, to put it mildly.

The first chart shows Rydex ratios – with bear assets throughout 2014 stuck at historical lows, the bull-bear asset ratio has recently hit a new record high above the 20 level (i.e., 20 times more Rydex assets were invested in bull and sector funds than in bear funds). This is incidentally quite a distance from the (then) record highs set in February-March 2000.

The second chart shows HYG, the HYG-SPX ratio and the TLT-HYG ratio. The most important takeaway from this chart is that the underperformance of high yield bonds relative to big cap stocks has reached a new annual extreme. A history of past occurrences of this phenomenon was recently shown at Zerohedge. Obviously, the lead times are highly variable, so this is not a timing indicator, but it certainly is a warning.

 

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(Photo credit: fmh)

 

The third chart shows how the Russel 2000 (RUT), the Nasdaq 100 (NDX) and the NYSE Composite (NYA) are performing against the S&P 500 Index (SPX). Small caps and the broader market are both underperforming the large cap stocks making up the SPX, while the largest tech and biotech companies are in turn outperforming the broader SPX. This phenomenon is typically observed near major market peaks. The problem here too is the definition of “near”, as once again, lead times tend to vary greatly (the late 1990s-2000 market so far exhibited the longest lead time in this respect).

The fourth chart shows an update of the Investor Intelligence sentiment survey. Tonight the latest data will come out, but judging from the trend this year and over recent weeks, new lows in the bear percentage could easily be reached. Last week, bears were at 14.8%, up slightly from the record low of 13.3% seen a few weeks earlier.

Lastly we show the Barron’s confidence index (which is a ratio of the best grade vs. the intermediate grade bond index). This indicator has been in a downtrend since the late 1990s and has just reached its major long term downtrend resistance line. This suggests it is probably close to reversing down again, but it could of course also “break out” (we believe a breakout isn’t very likely, but this remains to be seen).

 1-Rydex ratiosRydex money market funds, bear assets and the bull-bear ratio vs. the SPX – we have updated the annotations to reflect recent developments – click to enlarge.

 

2-HYG-SPX-TLTHYG (junk bond ETF), HYG vs. SPX and HYG vs. TLT. The underperformance of HYG vs. the SPX has reached a new annual extreme – click to enlarge.

 

 3-RUT,NDX and NYA vs SPXIntra-market divergences: RUT-SPX, NDX-SPX and NYA-SPX – click to enlarge.

 

 4-Investors-Intell-surveyThe Investor’s Intelligence Poll: bears are an endangered species here as well – click to enlarge.

 

5-Barrons Confidence IndexThe Barron’s confidence index (via sharelynx) – trending down since the late 1990s. It has recently bounced back to the downtrend line, which should provide resistance – click to enlarge.

 

Leverage, Liquidity and Trigger Events

The same signs of complacency and warnings signals that were evident previously continue to be evident – only, most of them have become even more extreme. It is worth noting that many of the sentiment and positioning-related data (along with a bunch of slower-moving data not shown here, such as margin debt and mutual fund cash, which we have updated fairly recently) are actually at, or very close to, record levels. Experience shows that the longer this is the case in parallel with extended valuations, the bigger the eventual backlash will be. As always, it is important to keep in mind that this cannot tell us when exactly the backlash will come, or what will trigger it. However, US liquidity is declining, according to a proprietary indicator calculated by UBS, which is confirmed by the recent slowdown in the rate of growth of Money TMS-2 (more on this tomorrow).

 

 

6-UBS-liquidity indicatorThe proprietary UBS US liquidity indicator – click to enlarge.

 

We believe US (Fed provided) liquidity is far more important to global risk asset returns than liquidity provided by the BoJ and ECB. The nonchalance about the end of “QE” is therefore somewhat baffling. The BoJ and the ECB can induce carry trades, which is potentially supportive of US assets, but they cannot influence the USD money supply – only the Fed and US commercial banks can do that (as one of our readers helpfully remarked recently).

The former is currently doing nothing, and the latter will likely have to reconsider their strategies (such as e.g. buying/monetizing US treasuries, and swapping them for junk debt to pocket the yield difference) in light of the potential for debt problems in the oil patch – since it is estimated that some 40% of US junk bond issuance in recent years has been tied to the fracking boom. The recent plunge in oil prices portends difficulties in this corner of the credit markets.

Leverage is extremely high, while investor cash holdings (in the form of money market fund holdings, mutual fund cash reserves and cash held in brokerage accounts) are concurrently extremely low, especially as a percentage of financial asset values. The amount of leverage is mirrored in margin debt statistics and hedge fund leverage statistics, and those represent only a small sample of total systemic leverage.

Moreover, a sizable amount of trading is nowadays fully automated. This reminds us of the automatism built into the infamous portfolio insurance strategy coupled with program trading in the 1980s. Today’s systematic trading systems all use by and large similar “technical” inputs, even though these are frequently tweaked (such as prices moving through moving averages, or other predetermined support levels, etc. – what can happen when they all trigger at the same time was demonstrated in the “flash crash” – the only “trigger” at the time appeared to consist of the S&P violating its 50-day moving average). There are also record amounts of outstanding options, most of which are hedged dynamically (via delta-hedging), which heightens the market’s vulnerability further.

 

Conclusion:

The only “trigger” needed for an upset is probably a correction that is fast and deep enough that it threatens to impair many of these leveraged positions. What the trigger will be and when it will manifest itself is unknowable – but it seems to us there is a lot of fragility built into the system already. Risk remains very high.

 

Charts by: StockCharts, Sharelynx, UBS research

 

 

 

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