The Bears Don't Get It

Includes: DIA, SPY, VTI
by: Josh Arnold

The US market continues to be extremely resilient.

Valuations are beyond stretched but that simply doesn’t matter.

Until something arrives to trigger a selloff, the market’s bias is higher.

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The broader market (NYSEARCA:SPY) has been a hot topic of late as we all sit around and gaze in wonderment about how it just continues to chug higher. There are plenty of hold-your-nose-and-buy investors out there but on the other side, bears abound as well. I've been both at points fairly recently but I've come to the realization that investors would do well to side with the former until conditions change such that it no longer works.

This chart shows the last two years of the SPY and for most of this time, the market has simply gone up. Dips have been few and far between and even when they occur, they are met with intense buying pressure and investors feel all warm and fuzzy again as everyone's 401(k) accounts continue to gain in value. And I get it; I like my 401(k) account perpetually moving higher just like everyone else does and to state something obvious, it has been a terrific time to be long in the past 18 months or so.

But how long can this last? That's the big question that bears continue to bring up and as I said, I have done this in the fairly recent past. After all, valuations are hugely stretched by any measure you can think of; there's no disputing that. Not even the most steadfast bull could make a case that today's market is cheap in some way. But does that matter? We've all come to accept the market (NYSEARCA:DIA) the way that it is, egregious valuations and all, so does it matter that the US market is so expensive? The answer is that it doesn't matter until it does; allow me to explain.

The factors that have powered the rally are still in place and until that changes, there is no reason to think that the rally will stop. The central banks of the world are still extremely accommodative at the moment, although some have begun the very long, laboring process of removing that accommodation. That's going to take a very long time, however, as it isn't like we'll swing back to tight monetary policy; the world's central banks are so afraid of deflation (with good reason) that any removal will be very drawn out and telegraphed so as not to spook the markets (NYSEARCA:VTI).

In addition, new money has to get put to work somewhere and right now, the US market is in a perfect Goldilocks state; every little dip is met with a wave of buyers that cannot seem to hit the button quickly enough and that's that. The most bears have gotten recently is some sideways action as a pause from the endless grind higher. Does that make them wrong? In a word, yes. After all, price is the only thing that matters as I've been "right" before but lost money and "wrong" but been on the correct side of the trade. Guess which one I prefer?

And that's the thing; fundamentally, I think our market is absurdly priced. There are bubbles everywhere, namely in consumer staples and dividend stocks and, one could argue, in large tech. These sectors have kept the rally going at one time or another in the past couple of years and until that stops, there's no reason to think that the rally will end. Should those sectors fall by the wayside, it will be important that something else picks up the slack. If that doesn't happen, we may see sideways action instead of a grind higher, but even that wouldn't be enough for the selloff we've been hearing was coming for the past two years. After all, extreme valuations can persist for a long time before something finally spooks investors into heading for the exits. And I'm not disputing that this is likely to happen at some point but I am saying that shorting the market or sitting in cash for years to wait for it is imprudent.

Indeed, at this point I'm not entirely sure what would actually bring about a sell-off and that is why, despite my bearishness on the fundamentals, I'm still in the hold-your-nose-and-buy camp. The chart above is screaming at you, pleading with you to follow the trend. The trend has been undeniable and powerful for several quarters now and while I'll reiterate that I don't find this market to be cheap, I do find it to be extremely resilient and friendly to buyers, not sellers. Until that changes, I'm still going to be long.

One note of caution is that if we switch the chart to a weekly view, there are some cracks appearing in the façade.

We have been near overbought territory on a weekly basis for a few weeks at this point and the other momentum indicators are showing some signs of fatigue. That is to be expected considering how we've moved up in a straight line for so long but at the same time, we certainly look due for some consolidation. If that consolidation begins and investors get spooked by something, this could all unravel. Given recent past, that certainly isn't my base case but with so much buying pressure in the past several months, the momentum indicators are begging for a respite.

In my view, as long as we hold 240 on the SPY, we should be in good shape. In fact, I'd welcome a pullback and consolidation at that level because it would give the market a break and when the bulls come back, they can power the next leg higher. While I don't particularly like how the momentum indicators look on the weekly chart, there are certainly no alarm bells ringing yet.

The bottom line is that while the US market is very expensive, what is going to cause a sell-off? Valuation alone is not enough as that has been proven over and over and over again just in the past 20 years. Something has to trigger a sell-off and right now, I don't see anything that could. Obviously, shocks arrive and move markets and that is always a possibility. But apart from that, buying the dips is still the prudent course of action despite the mountain of evidence that the SPY is extended. That alone isn't enough to try and get short in front of the freight train that is US stocks even if the fundamentals say the market is overextended. At this point, that is not what matters. What matters is that the structural reasons the market has continued to rise are still in place and until that changes, giddy up!

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.

Additional disclosure: I'm long broad market funds equivalent to S&P 500 and Russell 2000 exposure