Welcome To The Top Of The Market, Again

by: Greedometer

Back in October, I posted an article here at SA suggesting the stock market was topping out and would begin to roll over and initiate crashing (here's the article). It would be appropriate to update that view and the supporting data referenced.

For the record, the S&P500 dropped after I posted the October 9, 2012, article. The fact that the Fed had to launch QE4 to stop the collapse vindicates my point of view. Doubtless, markets would have continued collapsing (otherwise QE4 was / is a complete waste of time).

First, the big picture. The previous article made reference to the strategic Greedometer risk gauge. In October 2012, it reached 7000rpm. Two weeks ago the Greedometer gauge reached 7700rpm. This matches the peak reading seen in April-July 2007 3 - six months prior to the October 2007 market peak.

Greedometer gauge at 7700rpm

The previous article also made reference to an online tool called the interactive Greedometer gauge. The tool has been updated to reflect the addition of another parameter being added, bringing the number of input parameters to nine. (see www.Greedometer.com for the tool). Here's an image of the interactive tool:

interactive Greedometer

The new input parameter is called the Rats Jumping Ship parameter. The name reflects my low opinion of corporate insiders quietly but manically selling their own shares while claiming retail investors are under invested in stocks, or that their expert insider view of future business prospects is cloudy. Specifically, the new input parameter is the ratio of insider shares sold to bought, averaged for a four-week period, across all U.S. stock exchanges.

Insider buying and selling activity is obtainable from SEC form 4 and 5 filings, but it tends to be a bit of a mess. Argus Research does an excellent job at providing this data in an easy to use format.

Last week: Across all the U.S. exchanges, insider share sales were nearly 9.5X the number of insider share buys. This is the highest ratio of shares sold to shares bought across all U.S. exchanges -- since the provider of this data (Argus) began keeping records in 1998. This is panic selling. On the NYSE alone, insider share sales were more than 10X the number of insider share buys. Stunning.

It is instructive to note that this happened in early 2007, and again in early 2011.

Here's the chart of insider sells/buys (four-week average) for 2007. Insiders did an excellent job at selling into each rally, with the most manic selling early in the year.

The same thing happened in 2011. In April - July 2011, the Greedometer indicated the market was topping-out and would begin to collapse. I took out a 1/4 page ad in The Wall Street Journal (in July 2011) to announce this. The S&P500 dropped roughly 19% from early July to early October. The Fed and ECB had to spike the punch bowl again to stop the collapse. This chart (2011) looks a lot like the 2007 chart.

Here we are in 2013. The chart is starting out the same. (Yes, that's my forecast for this data set and the S&P500 for the rest of the year.)

Rats jumping ship 2013

If this collapse were to unfold as slowly as the one in 2007, you'd have until October to unload your risk assets (stocks, junk bonds, REITS, commodities). I don't see the party going that long this time -- despite the fact the Fed is going to leave a brick on the accelerator of the QE3 and QE4 printing press. Don't forget, in 2007 the U.S. did not enter recession until December. This partially explains why the S&P500 peaked in October (2 months prior). My estimate calls for the U.S. to enter recession in May this year. Hence a market peak in April looks about right.

Other datapoints in the previous article in need of updating:

The VIX: It is well known that when the VIX is seeing very low readings, fear must be taking a holiday. That's when secular markets occur. It should surprise no one reading this article that the VIX was posting extremely low readings for the past month (in the 12s). The last time they were that low was... before the market peaked in 2007.

The S&P500 Adjusted P/E: Once again, the past month has seen the adjusted P/E reach the 23s. This is where every rally since the 2009 bottom has gone to die. And why not ? -- 23 is a 40% premium over the long-term mean of 16.4. P/Es are mean reverting, and that's what's in the cards for 2013-2014.

S&P500 Profit Margin: More mean reversion. Profit margins reached all-time highs in late 2011 and have been slowly dropping since. Much further to go. FYI: 2007 saw profit margins peak in Q1 (three quarters prior to the market peak).

Greedometer Put/Call ratio: Please see the previous article for a detailed explanation. The short explanation is this parameter captures the difference in sentiment between large option market players with retail option market players. The past month has seen the large players heavily buying equity put options and retail options players heavily buying call options. In fact, the data on this input parameter over the past month looks remarkably similar to what was seen in early October 2007. Usually, when this parameter looks this way, the large options market players are proved correct and a pullback follows. Sometimes, the pullback is the first leg in a crash.

Advisor Sentiment: Over the past month, the ratio of advisors with a bullish view rose to nearly 55% vs 21% with a bearish view (a ratio of 2.6:1). As stated previously, when advisors agree in large numbers (and 55% is a large portion of advisors), you can rely on their (our?) collective group think wisdom to be wrong. FYI: the bull/bear ratio exceeded 3:1 in October 2007, and again in April 2011. I suspect it will approach 3:1 again in April this year.

Margin Debt: Over the past few months, the amount of money that investors were borrowing (on margin) from broker-dealers has sky-rocketed back up to approach levels seen a few months before the 2007 peak.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.