Sharon Is Now Bullish

Summary

• I have a weekend Heisenberg vignette for you.
• The last time the Dow closed at a record high for eleven straight sessions, Sharon was 45.
• You can hardly blame her for being bullish.
• Or can you?

I got up early on Saturday.

Earlier than usual.

Apparently, falling asleep to documentaries about the sectarian divide isn't conducive to REM sleep. Who knew?

Out on the porch in the predawn hours peacefully enjoying a morning smoke, I wave to the 70-something lady next door. Our places are separated by a couple of sand dunes between which sits an old, wooden skiff that's been there since I was a teenager and thus well before I actually bought this place.

But despite the fact that "next door" here doesn't exactly mean "next door" in the traditional sense, I can still hear Sharon (the neighbor) talking. It's a particularly surreal scene. She lets the dog (some manner of spaniel) off the leash, and it does what dogs do in the morning on the beach - it frantically runs this way and that, trying to decide which scent to chase before ultimately giving up and breaking into a dead sprint towards the surf which, in this low light, is like white foam on an infinite sea of black coffee.

Sharon is talking on a Bluetooth earpiece (something she absolutely loves doing as it apparently makes her feel less old). Given the hour, my guess is she's talking to her friend in Wales - a childhood pen pal-turned real pal thanks to modern technology. She's talking about Trump. And, hilariously, the market. She doesn't mention the Dow by name (she likely has no idea what a "Dow" or an "S&P" is). All she seems to know is what she heard on the nightly news; that stocks have closed at record highs for eleven straight days for the first time in three decades.

At first I just chuckle to myself, but then I thought about it for a minute. The last time the Dow hit a record for eleven straight sessions, now elderly Sharon was like 45 years old. That's pretty incredible.

If you look at the S&P (NYSEARCA:SPY), we've gone 93 days without a 1% pullback. That's only happened six times (counting this time) in the last 37 years:

(Chart: Goldman)

Here's a bit more color on the current rally out late Friday from Goldman (my highlights):

Earlier this month marked a full calendar year since the last 10% US equity market drawdown. The S&P 500 declined by 14% in February 2016. It has been more than seven months since the last 5% drawdown (6% in June 2016), and 93 trading days - more than four calendar months - since the S&P 500 last experienced a daily decline of 1% in early October. The last time the market exceeded that stretch was 94 days in 2006.

Long periods of market stability are not good indicators of drawdown risk. Since 1980, there have been only six instances of the S&P 500 trading for 80 or more consecutive days without a 1% decline. Following the end of these stable market periods, the S&P 500 actually registered a positive three month return in five of six episodes, with a median 6-month return of 9% and a 12-month return of 15%. In short, following previous periods of market stability, the S&P 500 usually continued to march higher.

Behold. The "greater fool," "I'll buy if you buy higher," theory of investing in all its historical brilliance:

(Chart: Goldman)

That's remarkable. In the year that follows a period defined by 80 or more consecutive trading days without a 1% pullback, the median return is 15%. The message, I suppose, is "all aboard" the bull train.

Goldman goes on to talk about risk. And they're not shy about suggesting that no matter what history says, we're likely looking at an asymmetric risk/reward scenario here that's skewed to the downside. Here's a bit more color from the bank:

The distribution of market outcomes appears asymmetrical in our view, but the market will likely continue to grind higher until a catalyst sparks a drawdown. Upcoming weeks include a number of major risks:

1. US government policy: Next Tuesday, Feb. 28, President Trump will present his State of the Union to Congress. Trade with China has been notably absent from recent headlines despite constituting a central pillar of his campaign. Protectionist trade policy is a risk lurking under the surface.
2. US monetary policy: Although most investors expect two or three FOMC rate hikes this year, the market prices just a 22% likelihood of a hike at the FOMC meeting on March 15. PCE inflation data released on March 1, Chair Yellen's planned speech on March 3, and/or the monthly jobs report on March 10 could raise the odds of a hike sooner than is currently expected.
3. European elections. In a busy calendar of European elections, the first round of the French presidential election will occur on April 23, with a potential run-off scheduled for May 7.

Investors seeking to own US stocks while protecting against upcoming risks can take advantage of extremely low volatility by replacing cash equity holdings with calls.

Note the implication there. Basically, Goldman is telling you this: "yeah, you know history is on your side and all, but if I were you, I wouldn't stick around to see how this plays out."

And from a valuation perspective, you can see why they say that.

Here are updated versions of the two most basic charts on the planet:

(Charts: Goldman)

I'm not going to go any further with the valuations story here because as you're no doubt aware, every single fundamental metric you care to consult says we're grossly overbought (cue the commenter who will patiently explain that fundamentals don't matter).

Rather, I want you to think about positioning. Here's what the latest CFTC data (out Friday afternoon as usual) shows:

(Chart: BofAML)

"Buyside continued to add to [their] S&P 500 net long [which is now] the highest since July 2015," BofAML wrote yesterday.

Recall the following chart I highlighted earlier this week:

(Chart: Nordea)

For those who don't know how to interpret that, here's Nordea's Martin Enlund to help:

Macro hedge funds all-in on equities.

Yes, "all-in" on stocks. And here are two more charts from Goldman to drive the point home:

(Charts: Goldman)

As usual, you're encouraged to make your own decision here. That statement is sure to vex those who (still) insist that my job is to tell you what to do with your own investments.

But while I won't opine on what's appropriate for your portfolio (indeed, how could I, given that I don't know you or what cards you're holding?), what I would say is the following.

When you hear people say things like "the market is always right," what they're implicitly saying is that there's no such thing as a mispriced market.

As you evaluate that claim with respect to current conditions, just remember this: Sharon next door, with her Bluetooth earpiece and her spaniel, is now bullish.

Disclosure: I/we 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.