One Chart that Says it All …
Similar to us, our friends at Sitka Pacific Capital Management are very wary of the stock market at its current levels of valuation and given its technical condition and the fundamental backdrop against which all of this plays out.
We have previously mentioned the 'parade of tops' and divergences that the market has served up: for instance, the NYA topped a full 18 months ago, which shows that the subsequent rallies were carried by ever fewer big cap stocks. But that is not all, and it is very instructive to look at a long term overview of the secular bear market in total and compare the progression of divergences that was in evidence at the two prior major market peaks with today's situation.
Sitka Pacific has published just such a chart in a recent letter to clients and has graciously allowed us to post an updated version of it here. The chart to our mind conveys primarily one message: one should not lose sight of the forest for the trees.
Often when reading critical comments on the market by the likes of John Hussman (whose most recent missive is once again a 'must read' by the way), which may appear over a lengthy period, while the market rather stubbornly refuses to fall, one may after a while become inclined to dismiss the warnings.
And yet, when looking back at a long term chart of the market, one realizes that it is usually worth to be patient while a lengthy distribution process is underway. One would actually do best to heed the many warnings the market often gives us over extended periods before finally caving in for good.
It is important to remember in this context that both the major moves up and even more so the major moves down tend to happen in very compressed time periods. For instance, 90% of the market's gains occur in just 3% of the time (we are quoting this statistic off the cuff and it is a little dated, so if there is an inaccuracy don't hold it against us - it is the principle that we want to stress).
When the market falls, most declines tend to happen even faster. So it is clear that when people become aware of warning signs, that the actual decline that will eventually follow on the heels of these warning signs will come at some later point - how much later is slightly different every time. The decline can after all only happen once and will as a rule tend to be very compressed. So it does little good to complain that it hasn't happened yet, because when it does happen, it will be fast and decisive.
Of course the concerns of short term traders are generally of a different nature, it is also important to point out that this entire discussion is actually mainly of use to longer term investors. However, even short term traders must be aware of the longer term backdrop, if only to remain alert to important character changes that are usually presaged by such technical divergences.
So without further ado, here is the chart:
How market tops develop, based on the divergences observed at the two major peaks of the secular bear market to date compared to the current situation, by Sitka Pacific - click for better resolution.