Everybody Agrees: Stocks Can Only Go Up More …

We have recently come across a paragraph contained in a Marketwatch “need to know” summary that strikes us rather ominous. The title was: “Corporate America and retail investors agree: We love equities”. It goes on to say:


“A box of chocolates, some Barry White and a stock market that just won’t quit. Whatever the aphrodisiac, love was in the air last month as investors embraced the Valentine’s Day spirit.

If there’s any fear of an imminent retreat in the markets, you wouldn’t know it by how enamored individual investors have been with equities lately. Stock and stock-fund allocations grew to 68.3% in February, marking the second-highest level since the financial crisis, according to the American Association of Individual Investors. We’re now going on 23 months in a row of equity portfolio allocations above the historical average of 60%.

Corporate America is every bit as smitten with equities. Its own equities, to be precise. Buybacks surged to the highest level ever recorded by TrimTabs, which started tracking the data in 1995. In February, CEOs announced $104.3 billion in repurchase plans.

A year earlier, that number was $55 billion. A contrarian might see that as reason to sell. But it wouldn’t have worked the last time buybacks took out a monthly record. That was $99.8 billion in July 2006, and the S&P 500 surged 23% the following 14 months before hitting an all-time high, Bloomberg data showed.”


(emphasis added)


moma soundings

Photo credit: Stephen Vitiello


When do retail investors and corporations usually agree to such an extent that there was never a better time to buy stocks than now? As a rule, they are only doing so after the market has risen for several years. Needless to say, they also agreed that the absolute worst time to buy equities was when the S&P 500 traded below 700 points in early 2009. Stock buybacks collapsed at the time and retail investors yanked record amounts from stocks. The Daily Sentiment Index showed a mere 3% of S&P futures traders were bullish at the March 2009 low.

The caveat mentioned above that when buyback records were broken in 2006, the market still kept rising for a while before entering the twilight zone of the financial crisis should of course not be dismissed out of hand. However, no two periods of market history are exactly the same. What worked last time, may not work in the same manner this time. There is another parallel with 2006, and that is the fact that the market was overvalued on both occasions – only, it is a lot more overvalued now. As we have previously pointed out, in terms of the median stock, the stock market is actually at its most overvalued level in history.

This does not tell us anything about when the apparently at the moment not-so-much-dreaded reversion to the other extreme will begin; even extremely overvalued markets can become more overvalued after all. However, what the data indicate is that contrary to e.g. 2000, when the market previously experienced one of those moments when both retail investors and corporate chiefs were in full agreement that there was never a better time to buy, there are few places to hide this time. Only a tiny handful of sectors can be called potentially undervalued, and their fate is in most cases tied to commodity prices – not really a good position to be in at the moment either.

Another parallel to 2006 is that economic activity in the US is actually decelerating rather noticeably of late – notwithstanding today’s strong payrolls report (employment is a lagging indicator, which incidentally makes it rather odd that the Federal Reserve uses it as a major determinant in its interest rate manipulation policy). Here is a recent chart from John Hussman illustrating the situation:


1-US economic activityUS economic activity based on industry surveys


Once again though, this doesn’t tell us anything with regard to timing either. What makes the situation interesting is the fact that the Fed has talked itself into raising interest rates in spite of the developing weakness in economic data. This is not a comment on whether upcoming Fed policy decisions are “right” or “wrong” – with regard to this, we are taking the principled stance that this central economic planning agency shouldn’t even exist. We are only mentioning this because we happen to believe it would be a potential double-whammy for the overstretched stock market if the Fed were to begin hiking rates just as the economy begins to soften.


Quantitative Sentiment Indicators

As a complement to the evidence mentioned in the Marketwatch comment above, we like to watch a number of sentiment data that are not very widely followed. As readers know, we are always keeping an eye on Rydex fund data, in spite of the relatively small amount of money invested in the Rydex fund family. The important point for us is that these funds are a useful microcosm of small trader sentiment. Just two trading days ago, the extreme in bullishness that has already been in evidence for most of 2014 managed to reach a new all time record:


2-Rydex ratiosRydex bear assets fall to a new record low, and the bull/bear asset ratio nearly hits the 30 level, which is likewise unprecedented.


Another indicator we are keeping an eye on is the “smart/dumb money” confidence spread published by Sentimentrader. Since this spread is mainly calculated on the basis of real money gauges (i.e., positioning indicators like futures and options trader positioning), it is also quite useful in spotting extremes of sentiment. The spread has just hit the worst level since late 2010, a few months before the 2011 correction (which was the biggest market correction since the cyclical bull market started in 2009):


3-confidence spreadThe “smart/dumb money” confidence spread, via SentimenTrader – click to enlarge.


There seems to be the idea that nothing untoward can happen to the market, simply because stocks have ignored all negative real-world developments up to this point. However, this is the wrong way to look at it. The way this tends to work is that the things that have not mattered so far, will begin to matter once prices turn down.



We disagree with retail investors and the heads of listed corporations: Very likely, now is not the best time to buy stocks. Although we obviously have no crystal ball either (we’ve been skeptical for quite some time), we do know as a general rule of thumb that the longer extremes in valuations and sentiment persist, the more painful the eventual denouement is likely to become. It will also be widely unexpected, a precondition that seems definitely in place at this point.


Charts by: StockCharts, SentimenTrader, John Hussman




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One Response to “US Stock Market: Is the Bell Finally Ringing Loudly Enough?”

  • HonestlyExpressingYourself:

    It’s axiomatic that markets feel most safe right before their biggest crashes – this is why market tops tend to be spiky, not plateau-like, elongated slopes of increasing uncertainty that then gradually start heading south. When we look back at 2007 or 2000 and see the confident final upsurge that took the market to its peak, we must ask ourselves: ‘what were people thinking?’. it’s tempting to think they kind of knew what was coming but just pretended – as long as the music’s playing you keep dancing to get that last 5-10%. But markets don’t go up on such weak confidence. They have to have real true believers otherwise they don’t go up. In other words, right before the peak people really truly did believe! it certainly looks like we’re there again. Though it’s looked that way for nearly a year. Maybe the market just needed to get everything on its front-of-mind wish list first, ie it has been waiting for ECB QE, Fed interest rate hikes (supposed ‘normalisation’). Once it has everything it needs, paradoxically it will be free to roll over. When it rolls over it will become apparent (in hindsight) that that wish list was too narrow. Strong dollar, weak eps, weak global growth, reckless borrowing, inflated equity valuations, silly buybacks etc. will come down with a vengeance on markets and seem more important than the central bank policy they’ve been obsessing about this bull market more than anything else. The idea of something is often more powerful than the thing. Hence buy the rumour sell the fact. With markets apparently getting everything they’ve wanted, and all their fears quelled, it’s time to move to the next paradigm.

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