When stock market speculators are positioned mega-bullishly after months of almost straight-up stock price movement, either it's a new era or it may require lower prices for a while - or at least a period of consolidation to attract new buyers who are willing to pay yet higher prices.
Because market valuations are heterogeneous, I'm not bearish on every stock (it's not September 1, 2008 in the United States, even if times are tough in some other venues), but I'm negative on such major ETFs as the S&P 500 ETF (SPY) and the iShares Russell 2000 Index (IWM). Here are some of the recent reasons why I am now leaning toward the correction/consolidation camp for U.S. stocks.
One the one hand, the worsening action in the metals and other commodities is sending a strong bearish, "risk off" signal - precisely as net speculator positioning in all four of the major stock contracts traded on the U.S. exchanges has reached or come close to at least a 5 1/2 year high (strong "risk on" signal). The last time I recall this sort of intermarket correlation breaking down this way was in the spring of 2011. First, I want to update the action in copper before discussing stock index futures positioning in detail:
What I noticed after my recent article on Doctor Copper was published was the rapidity of the reversal of the large speculators from heavily bullish to heavily bearish (red line). All in all, large speculators are smart money. In futures market theory, they exist to provide insurance for commercials, who want to hedge their risk. So as does any insurer, the speculators exist to judge the market correctly and make a profit. When they jump fast and strong from one positioning to the opposite one, that informed view should be respected.
As a reminder, the green line in the positioning of traders represents the commercial interests, who are generally true hedgers. The sum of the large and small traders' positioning (red and blue lines) determines the net positioning of the commercials.
That gold is now in a renewed downtrend suggests a lack of liquidity in the global financial system, as happened when gold was in its bear phase during the illiquid parts of 2008. Once the liquidity tap was turned on, gold went from as low as $700 to as high as $1900 per ounce in less than three years. Jim Sinclair posits that gold's fate is to be bid up when global liquidity is strong and to be bid down when it is shrinking. He's "Mr. Gold," and whether he's right or wrong on gold's future price range does not change my view that this is a sensible way to view gold's price action now. After all, the head of the Eurogroup is Dutch, and the Dutch have their own collapsing housing bubble to give them liquidity issues. Except for Germany, it does not appear that any major member of the eurozone is flush with liquidity. Plus, the European Central Bank is forbidden from monetizing government debt, though it has come close with the Long Term Refinancing Operation (LTRO), and it may be maxed out as well. This may explain the way Cyprus was handled. Money may simply be getting tight in the eurozone.
On the other hand, in stark contrast to the message from both copper and gold, U.S. stocks continue on their merry way (Wednesday's dip notwithstanding). As we see from the S&P 500 contract, commercial hedgers are heavily short the market on the mini contract and are also short on the full-size contract.
The amount of net long positions, which equals the net commercial hedger shorts, is the highest since the post-Lehman collapse period.
That by itself is not at all disconcerting. What is troubling, in the face of the clear message from gold and copper, is that all the indices have similar bullish positioning from the speculators. Here, for example, is the NASDAQ 100 index:
Net longs in the mini contract have rarely been higher.
The Russell 2000, which I view as this bull market's equivalent of the NASDAQ of the late '90s, apparently used to be used by futures traders as a true hedging mechanism, as they were short the index for years until recently, but lately they have seen no need to short:
According to the iShares website, the trailing twelve-month P/E on the Russell 2000 is around 26+. Growth (documentation elsewhere) is around 5% per year for the past 5 years. Thus the P/E/G is around 5 - very high. So, previously the traders in this index shorted it either naked or to hedge other longs, but now that it is so expensive, of course they love it and are brave. How bull markets doth make investors brave!
Even the Dow, which for some reason has futures, lightly traded though they are, shows that speculators are quite bullish there as well:
Here, the longs in the mini contract are merely high but not near a record, but this being the staid Dow, the full-size contract is where the action (such as it is) may be has a near-record number of longs among the speculators.
In addition to the uniformity of opinion seen in the above mini index futures charts, there are no net speculator shorts among the standard contracts either. This is the first time I can find that phenomenon. For example, from 2010 through 2011, speculators were frequently net short the S&P mini contract even if they were net long on the NASDAQ 100.
My sense is that this is a warning sign of some importance. Leveraged speculators are uniformly bullish on stocks at record prices, whereas they were a good deal more cautious at lower prices. At the same time, troubles in the commodities complex show a divergence. Traders cannot possibly think that the U.S. stock market is truly a "risk off" safe haven, can they?
We now have many of the standard ingredients for a correction in a mature, ongoing bull market. In addition to the above, the Federal government has just raised taxes and cut spending. The Fed is hinting at an exit strategy, per the dovish John Williams, who said today:
"Assuming my economic forecast holds true, I expect we will meet the test for substantial improvement in the outlook for the labor market by this summer," Williams said. "If that happens we could start tapering our purchases then. If all goes as hoped, we could end the purchase program sometime late this year," he added.
The Fed is actually said to be concerned about the loose lending standards that have been metastasizing in this country. I do not take it as a coincidence that a dove gave this speech. The Fed is probably not pleased by imprudent lending standards. So both the Federal government and the central bank are not so "growthy" right now.
The message I take from the points made herein is that a broad stock market ETF is a risky asset with which to seek alpha at this juncture. (It may really be a stock-picker's market!) Cash may not be so trashy for a while, either. Treasuries have already had a decent move to the upside in price (down in yield), but if a correction is underway, I would expect them to appreciate a good deal more even from here. But some of the "easy" money has already been made there, and the lower yields go and the more the Fed hints at an exit from QE, the more inherent trading risk Treasuries likely have.
Often, patience is needed to get a sense of how important divergences resolve themselves. This may be one of those times.
Additional disclosure: Not investment advice. Long gold. Long individual stocks.