What Megaphone? Tell Us How High Will We Go!
Yesterday Art Cashin remarked that (we are paraphrasing): "Everybody is asking me how big a rebound we'll get once the budget impasse is over."
Nothing illustrates the current stock market psychology better. People are not at all afraid of a big decline because the budget talks may continue to falter - all they are interested in is 'how high will we jump once the rally resumes,' as though a resumption of the rally were a birthright.
The reality is though that from a long-term perspective, the market continues to be in a very precarious position. Our friend B.A. has mailed us an updated chart of the SPX megaphone formation we have previously discussed in these pages. We have added an alternative interpretation of the wave count in black brackets to the proposed A-B-C-D(?)-E(?) wave count shown in the chart annotations, but note that this doesn't alter the ultimate conclusion. Also, keep in mind that this is something that could happen, but obviously doesn't have to happen. The secular bear market could reach its long-term trailing P/E target below 10 in other permutations of prices and earnings as well, especially if the central bank continues its massive inflation program without pause.
The long-term megaphone formation of the SPX, with two possible wave counts
For a long time it has been pointed out that retail investors have been sitting out the rally from the 2009 low, and it is true that households have reduced their direct stock holdings. But inflows into mutual funds have broken a few records this year, as mom and pop are apparently trying to make up for lost time. Moreover, retail money market funds have declined just as much as they did during the 2002-2007 rally, and as a percentage of market capitalization they have recently reached a new 33-year low:
Retail money market funds in absolute terms and relative to market capitalization
Of course we have seen time and again that the consensus has been rewarded in recent months and years - in fact, we cannot recall another period when this has been so consistently the case. The bull market of the 1980s and 1990s for instance always had its fair share of doubters until the final blow-off into the Nasdaq mania top from 1998 to 2000 got under way.
In the rally from the 2009 low, positioning and sentiment data have been continually in territory indicating extreme bullishness since at least 2010 (there are a few exceptions such as the very volatile AAII survey, but we have for instance seen record highs in options and futures speculation that have absolutely dwarfed all previous records).
In that sense, a knee-jerk rally following a budget deal can probably not be ruled out, or rather, is almost bordering on a certainty. The question is how quickly it might fizzle out (after all, there is really no good reason why such a deal should benefit stocks).
The bullish cause has been greatly supported by strength in technology stocks and small caps. Normally relative strength in these sectors is a good sign for the market's prospects. However, yesterday a wave of selling hit a number of bubble favorites, such as YELP, TSLA, CRM, P, AMZN and so forth, and it continues so far today. It should be remembered in this context that both the major peak in 2000 and the peak of 2007 occurred hand in hand with great relative strength in speculative technology stocks.
In short, strength in these shares is not always a good portent - it also tends to appear close to major turning points. Naturally, there is nothing that differentiates one situation from the other while it happens, but the action thereafter is usually telling. Here is a daily chart of the NDX that shows that the index fell out of its short term wedge formation yesterday (today's action is not shown, but the decline was still continuing as of the time of writing):
NDX daily: breaking away from the shortest term wedge to the downside
However, the much larger weekly wedge remains of course unmolested thus far - note though that prices have attempted to break out to the upside and were rejected from that point. This may be a typical 'throw-over' - a last gasp, so to speak:
NDX, weekly wedge - note the 'throw-over'
Finally, on a long-term basis it can be argued that wave C of the secular bear market in the NDX is still missing. In fact, this appears highly likely not least because on a long-term basis, a number of major indexes continue to exhibit divergences, with some indexes and averages making new highs, while others remain well below their old highs. The NDX itself is a case in point.
Below we show B.A.'s long-term wave count of the NDX, which strikes us as a high probability interpretation. Usually when wave counts look fairly obvious, they are in fact correct.
In many ways there are similarities between the long-term structure of the NDX and that of Japan's Nikkei. However, the NDX has generally managed to make higher highs at points where the Nikkei tended to falter at lower or only slightly higher highs. The difference can in our opinion once again be explained by monetary inflation, which has been much higher in the U.S. since the end of the 1990s bubble than in post-bubble Japan. U.S. money TMS-2 has grown by 230% (!) since 2000, vastly outpacing the de minimis growth of money TMS in Japan after the conclusion of the 1980s bubble. We have actually very little to show in terms of stock prices for such a huge amount of monetary inflation, but it has without a doubt kept stocks from delivering an even worse performance in nominal terms. Keep in mind though that this is just another symptom of Fed induced price distortions. Buying after inflationary policy has pushed prices into the stratosphere can be very dangerous.
A long term NDX wave count since the year 2000 mania peak, via B.A.
Mutual Fund Cash Levels
Lastly we show a recent chart of the cash-to-assets percentage of mutual funds. In spite of large inflows this year, this percentage (at 3.8%) remains only a tiny bit above its all time low recorded in 2011, and remains below the low recorded in March of 2000 (4.2%), which in turn was an all time low at the time. In other words, all the fresh inflows were immediately invested and mutual fund managers as a group continue not to see any downside potential. They have obviously been correct over the past three years, but the persistence of such bullishness makes the market more, not less dangerous.
Mutual fund cash-to-assets ratio, via sentimentrader
Yesterday we received news that the next Fed chairman will be the person the bulls all wanted to see in that post - Janet Yellen, who is widely considered a major dove.
It remains to be seen whether that will be enough to deliver an ever onward and upward march of the stock market. We doubt it, not least because in the past the arrival of a new Fed chairman has invariably been followed by a major financial crisis in short order. This may of course merely be a sign that the current monetary system produces major crises with great regularity, but still, it is a noteworthy coincidence (most recently: Greenspan and the 1987 crash, Bernanke and the 2008 crash).
The fact that so many people feel absolutely certain that the major thing to bet on is the 'post budget deal rally' gives us reason to believe that the often discussed longer-term wedges in the indexes may be ripe for a breakdown rather than a blow-off rally, although we certainly admit that the last word on that point is not yet spoken.
Charts by: B.A. / StockCharts, Sentimentrader