Summary
- Greedy Euphoria is here, but could it get more delusional?
- Markets are overvalued globally, but could they get more overvalued?
- When is a bull market over?
- Keep an eye on options and volatility for clues.
I was talking to a friend who made 8 figures as a trader and investor. He’s a big time biotech investor. Worked with Morgan Stanley and a guy who became a top trader for Stanley Druckenmiller.
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Stanley Druckenmiller: Net worth $4B+ as an investor. Was fired by George Soros then rehired leaving Soros’ hedge fund in this guy’s hands. Helped bet against British Pound in 1992 trade that reportedly made a billion dollars. Closed Duquesne Capital in 2010 to manage own money and that of several friends. Comparable long-term performance record to Buffett. Last year said “buy the disruptors, sell the disrupted.” Also said this recently: “I’ve made some money predicting boom-bust cycles. It’s what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had ever seen was preceded by an asset bubble generally set up by too loose policy…”
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I asked my guy, “when does an irrational bull market end?” He said: “when everyone believes it’s a bull market.”
There Are A Lot Of Bulls
Over the past several weeks, I think most of the holdouts now believe we are in a bull market. I’ve heard so many things from investors that remind me of 1999 and 2007:
The Fed has got our back.
A vaccine is coming soon.
The economy is about to grow like gangbusters.
Stocks will go up through the election.
Stocks will go up if Trump wins.
Stocks will go up if Biden wins.
Not a word about valuation from the bulls. Not a word about record unemployment. Not a word about record FHA mortgage delinquencies. Not a word about dramatically higher credit card and auto loan delinquency rates. Not a word about missed commercial rents.
Nope, it’s a bull market and that’s that. Ride it!
But Is It A Bubble?
The CNN Fear & Greed Index is stuck on Greed. But not the extreme greed that usually signals a correction.
Over at Citigroup, they place market sentiment squarely in euphoria:
We know that valuations are crazy high. But, markets can remain irrational a long time.
So, we have two components of bubbles. Greed and euphoria, as well as, overvaluation. But, both could still get more extreme.
How can we tell when the end is nigh? Let’s think outside the box a moment.
A Sort Of Conspiracy Theory And Tighter Then Realized Liquidity
I think there are 3 types of investors right now. Those who are bullish on President Trump. Those who are bearish on President Trump. Those who just wanna ride.
The Trump bears, those who think that a Trump win could cause a stagflationary depression (like me), are largely out of the stock market. At least, they are not committing new money.
Consider that Warren Buffett and George Soros aren’t scooping up stocks right now by all reports. Think about folks who just don’t like President Trump. Do you think they are investing heavily?
I have contact with hundreds of investors per month, I don’t think Trump bears are investing new money. I consult on, manage or influence nine figures of assets and that’s what I am hearing.
Call it a buyers strike or folks just uncomfortable with the investment climate. Either way, it has an impact, and limits the number of greater fools to push stocks higher. I think that is a reason that the euphoria numbers aren’t quite as high as possible.
That leaves a lot of what happens in the market short-term to the “just wanna ride” crowd. This broad group has a few subgroups.
- Indexers who just plod along dripping into stocks long-term. They’re a sort of baseline in my mind.
- “Young” investors, the so-called “Robin Hooders.” This is a group I have discussed before, primarily Millennials, starting to show their future dominance of market trends.
- Traders. Oh, the traders. I have been telling investors since very late 2017 that traders have a lot of power in a thinly traded market.
Volume has plummeted. We have seen this game before. Before most other major corrections, including both of 2018’s, as well as, in the months leading up to the Coronavirus Crash (which I think would have been a valuations correction if there hadn’t been a pandemic).
What if the traders can shake the Robin Hooders out of the forest? Moving risk assets with volume this low could cause a tsunami of selling.
Consider liquidity. Low liquidity is the hammer if there is a rush to the exits. And what if the Trump bears remain on strike until after the election? Those “limit down” days should not be far from memory.
Keep An Eye On Options
I have been tracking the put to call ratio for a long time. It is at extreme lows right now.
Does that look like alligator jaws to anyone?
What do alligator jaws always do eventually?
Interestingly, “skew” is elevated showing that protection trades are relatively expensive despite only a minor uptick in interest in puts – see bottom right of the chart above.
Technically Speaking
We track 4 key indicators: Relative Strength Index [RSI], Money Flow Index [MFI], Chaikin Money Flow [CMF] and the Moving Average Convergence Divergence [MACD]. RSI, MFI & CMF all touched or got very close to key overbought levels recently for the SPDR S&P 500 ETF (SPY).
Those are all daily charts and indicative of small corrections on their own. In the context of the weekly charts however, there should be concern for a larger correction, though maybe not new lows.
Many would suggest that because the weekly is not overbought, merely approaching, that there is still upside in the stock market. That could very well be true given that the Fed money printer go brrr.
However, look at other two piece corrections. I think 2018 is most similar given the market structure is built on the same tax cuts and deficit spending. The second and deeper correction in Q4 2018 never got overbought on the weekly after the initial early year “unwinding of the short vol trade” correction.
In short, I do not believe we need to see an overbought weekly chart this soon after a correction. Where it sits now is a warning sign. The other indicators are essentially similar.
So that leaves us with MACD. Luckily we have “Option Girl” Bonnie Gortler helping us. Bonnie spent 30+ years working with the developer of MACD while managing money. She has a great free piece describing how to use MACD here.
You can see how MACD is threatening to cross over on the daily chart. That doesn’t mean it will happen, but it doesn’t look good. The market is at a clear crossroads. One of the the ancillary things Bonnie looks at is breadth, and that has turned negative as decliners have outpaced advancers in recent days. Not a sign of a healthy market.
Investing Thoughts
As I said in our free Friday webinar a couple weeks ago, it is time to move to the conservative edge of your long-term strategic asset allocation.
Strategic asset allocation is the planned investment levels by percentage of your portfolio that you gravitate to. Tactical is what you are doing in real time based on conditions. So, tactically, we are saying get as conservative as your long-term range allows.
We have three categories of risk tolerance with each having different high-end cash positions right now:
- Defensive investors, mostly retirees: 50-75% cash.
- Cautiously Optimistic, usually working and earning wages still: 25-50% cash.
- Pedal To The Metal, more aggressive and more likely to short than hold cash: 10-15% cash.
To make it simple, sell broad based ETFs and mutual funds first. Sell the SPDR S&P 500 ETF (SPY) which is loaded with zombie companies that I described weeks ago here and here.
Then, plan to invest using the barbell strategy I discussed here.
For now, though, you need to be a seller, this rally is on its last legs or maybe already over.
Disclosure: I am/we are short SPY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own puts on the SPY.
