Turning Point?

New moon today, and a seasonal geomagnetism (inverted) peak around now:

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Sunspots have been rapidly waning too.

Price action in US equities has been up and down this week, but there has been a more pronounced trend change in European indices. Meanwhile, precious metals have consolidated their breakout and treasuries have advanced again.

Utilities continue to outperform and at the end of Q2, YTD sector performance looks like this:

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Which fits with this:

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Bears have largely capitulated, as evidenced in readings in Investors Intelligence, NAAIM, Rydex, and more, whilst complacency is extreme, as evidenced by put/call ratios, Vix and more.

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Cyclicals to utilities, high yield to treasuries and Dow-gold ratios have all turned down again, signalling risk off:

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Several Sentimentrader charts are signalling a trend change:

27ju2 27ju3 27ju12Whilst the Sornette bubble continues to flag as ripe to pop.

The US indices are ideally placed to turn, with the Nasdaq Composite at a double top, and RUT and IBB at potential lower high second chance peaks.

27ju6And we had a major bad economic data item this week in Q1 GDP:

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Equities have frontrun a return to ‘normal’ growth in both the economy and earnings, yet neither are occurring. Earnings season beginning early in July has the potential to add to the GDP disappointment and help cement the doubt and feed a downtrend.

To add to all the above, various divergences and indicator flags are mature. I maintain the reason for price advancing despite all these headwinds is the solar maximum driving speculation. If price continues to advance from here then I suggest the solar maximum isn’t done. However, evidence still points to the smoothed max likely being behind us, befitting peaks in markets spreading from December to June, around a Feb/Mar centre. If so, equities are ripe to fall here and deliver the potential of the combined above set-up.

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As Things Stand

1. SP500: bulls still in charge, whilst put/call, vix and volume continue to warn of a likely pullback.

24ju62. The speculative-target sectors and indices are still able to print double tops or lower highs here, there has been no breakout as yet:24ju83. Gold, silver and miners got a burst higher last week. Needs follow through this week if not just a short covering rally.

24ju94. Skew has leapt back up to historic extremes:

24ju25. Buying climaxes surged last week:

24ju16. Bubble-end still flagging:

Screen Shot 2014-06-24 at 07.24.14

Plus, various sentiment measures still at high froth levels.

Sp500 is within touching distance of 2000, so maybe it can tag that before reversing. This Friday is the new moon, which is another potential top marker. Various indicators are repeating in June what they did in December-January, which was before the deepest pullback of the year, so maybe we finally see exhaustion here. I am holding my positions and watching and waiting.

Cross Referencing

Wim Grommen argues there have been 3 industrial revolutions: 1780-1850, 1870-1930 and 1940-2000. They terminated with major peaks in the stock market and then gave way to degeneration phases.

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Source: Wim Grommen

My perspective is demographic booms in the 1920s and in 1980-2000 made for economic and stock market booms, culminating in mania peaks at solar cycle maxima, and then giving way to prolonged economic downturns and secular bear markets once demographics turned.

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A third perspective is that both episodes in history were based on a major run up in debt, or prosperity taken from the future:

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In short, the two periods rhyme. Parallels have been drawn between the Great Depression and the Great Repression in terms of severity of crisis, slowness of jobs recovery and bank failure risks. Similarly, central bank intervention became a dominant factor, with ZIRP and emergency spending programmes being required.

However, the Great Depression was much worse in impact when we consider number of failed banks, level of economic decline, drop in prices, and this despite the 2000 asset boom being a more extreme mania than 1929. One key reason for that was the aggressiveness of central bank response this time round, with more flexibility and conviction to draw down harder and faster on prosperity from the future.

Central banks cannot overcome demographic trends and post-mania busts, but they can postpone their full impacts if they are prepared to pay for it, helping stop the devastation being so front-loaded. So, the bear market from 1929 to 1932 was totally devastating and took valuations straight to bottoming levels (shown at -56% below), whilst the 2000-2003 bear was halted at still expensive valuations. 2009 then washed out valuations lower, and I believe we are on the cusp of another bear which will wash out properly. In other words, central banks have succeeded only in phasing the devastation, and the next leg down ought to be the worse: more of a deflationary depression.

12ju5Source: DShort

That projection can be cross-referenced with the demographic trends chart further up the page, and is further strengthened at a global perspective by similar demographic trends in Europe and China.

Between 1932 and 1937 a cyclical bull market erupted with distinct similarities to today (see post here). There was one solar cycle between the 1929 and 1937 peaks, and one between 2000 and 2014 (shown above). The 32-37 bull topped out along with the solar maximum in Spring 1937 with no divergence in cumulative advance-declines, which I believe will mirror today: an all-in peak at extremes in valuation, sentiment, leverage and complacency.

11ju9Source: DecisionPoint

Here is evidence that we have reached such extremes:

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And the bubble-end flag is raised:

Screen Shot 2014-06-14 at 12.31.20Source: Financial Crisis Observatory

And this fits with solar cycle maximum peak-speculation timing.SolarCycleSpeculationPeaksFriday’s session provided a bounce at the full moon. The bounce came at an important level in the large cap indices: a backtest of the ending diagonal or wedge. As full moons often mark inversions, that gives two reasons for stocks to rally again from here. However, by various indicators further declines appear more likely, and such a development would then fulfil the ending diagonal overthrow pattern, whilst ensuring lower highs are maintained in the small caps. That would then enhance the likelihood of all the indices having peaked and the smoothed solar maximum having passed. Emerging new up legs in gold, miners and silver are another clue that could be occurring, whilst geopolitical developments in oil could be a catalyst to end the complacency.

The best cross-referenced case I have currently is that the smoothed solar maximum, RUT, COMPQ, IBB and margin debt all peaked out around February/March. The majority of solar forecasts support this, and we have seen various asset peaks between December and June around this centre. The Sornette bubble-end is flagging again here as sentiment, valuations and complacency are all at the level of extreme that would fit a reversal, plus certain divergences are mature. The selling on Wednesday and Thursday did little to reset the short term indicators that would suggest stocks rally again now.

However, the risk remains that the solar maximum could potentially get stronger yet. Solar scientists have not so far done great in their predictions for this cycle. They are generally united in projecting a waning sun for the rest of this year, but SIDC still continue to run with an alternative model which would delay the smoothed maximum until the end of 2014.

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Source: SIDC

Right now sunspots are high again as the sun has leapt back to busy in June after three months of waning, so I continue to monitor. Cross-referencing again, if the smoothed solar maximum were still ahead, then we ought to see large caps hold their breakout here and continue to advance, the other indices break upwards to new highs (invalidating their Feb/Mar peaks) and margin debt reverse its waning trend.

So, as things stand, the highest probability case is for this to be the end of a topping process that began at the turn of the year, with the solar and speculation peak centred around Feb/Mar. If so, then stocks should fall again this coming week, fulfilling the ending diagonal and bubble-popping, and completing the ‘second chance’ lower peaks in RUT and COMPQ. If instead the large caps hold the break and rally upwards, taking the Nasdaq Composite along to new highs in the process, then it would strengthen the case for the solar maximum and peak speculation to be shifted along to at least June, but potentially to even further out in the year. An important week.

The End Is Nigh

1. Sornette bubble end flagging and potential ending diagonal overthrow price pattern on SP500:

Screen Shot 2014-06-11 at 09.04.51

Source: Financial Crisis Observatory / my annotations

2. Dtrend flagging uptrend exhaustion:

11ju10Source: Rory Handyside

3. P/e over Vix ratio at peaking level:

11ju1Source: ZeroHedge

4. Put/call, volatility and volume collectively suggesting an inversion:11ju12

Source: Stockcharts

5. Sentiment at lop-sided extreme:11ju3

Source: Not_Jim_Cramer

11ju19Source: STA Wealth

6. Junk bond spreads divergence as per the 2011 peak:

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Source: RightSideOfTheChart

7. Biotech has made a 61.8 fib retrace of the decline from the parabolic peak, as a potential lower high per the bubble anatomy model:

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8. Rydex data provides another example of the peak in leverage now being in the past, which along with margin debt should mean the markets are on borrowed time:

5ju10Source: Sentimentrader

9. A geomagnetic storm hit at the weekend and we are heading into this coming Friday’s full moon: twin negative pressures on sentiment.

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10. Economic surprises are negative in USA, Europe and China:

Screen Shot 2014-06-11 at 08.56.43

Source: Citigroup

11. 75% of companies in the US that have issued earnings guidance for Q2 2014 have issued negative guidance.

12. Gold and silver short interest at levels suggestive of a rally in precious metals, which would fit with a decline in stocks.

11ju21Source: TheDailyGold

In summary, it’s another compelling set-up. Whilst I cannot rule out stocks breaking higher and going crazier yet, I have to doubt whether sentiment, complacency and bubble/froth indicators really can get more extreme. As per my Sunday post, Piecing It All Together, my primary case is for this being the last piece of the topping process, particularly so in honouring the combined February peaks in the sun, in margin debt, and in RUT, IBB and COMPQ, i.e. lower highs here are important. If selling can initiate here, then exit will be through a keyhole due the lopsided all-in extremes.

Comparison to 1937

1937 was a solar maximum, like 2014, and notably the stock market peaked out despite negligible interest rates and with preceding QE, i.e. it was an atypical bull market end: easy conditions, no over-tightening. Stocks were run up on relatively thin volume and low participation to a Q-ratio valuation of over 1, in a 5 year rally. Stocks topped out 1 month away from the smoothed solar maximum without any notable trigger event. They had front-run a significant pick up in earnings and the economy that failed to materialise, and later in 1937 the US economy slipped into recession.

2014: we have had a 5 year rally since 2009, set against ZIRP and QE. Stocks have been run up on low participation to a Q ratio valuation of over 1, front-running a return to ‘normal’ earnings and economic growth that demographics suggest will remain elusive. In 1937 the thin volume allowed the market to rise easier, but then also to fall easier, and we have the same low volume now. Speculation should peak out close to the smoothed solar maximum, which looks most likely to have been around February. Unless the sun get busier yet, then we might expect stocks to be topping out. Evidence from sentiment, euphoria, divergences, leverage and asset allocations suggest this is indeed likely.

The weak economy and exuberant stock market are at risk of a deflationary shock, but failing that, realisation that 10% earnings growth and over 3% GDP growth are not going to happen again is bubbling under the surface. In other words, some surprise bad news could provide the requisite dent in confidence in equities, or stocks could roll over without a strong GDP print for Q2 (release 30th July) or an impressive Q2 earnings season (reporting starts 8th July).

1937 provides an example of stocks topping out on overvaluation despite easy money conditions. Other historic examples of equities front-running to over-valuation were also resolved by a bear market. Timing the top in 1937 came down to pinpointing the peak in the sun’s activity, and I believe this is the same challenge in 2014.

USDJIND1937cr9ju2Source: Stockcharts

9ju3Source: TheChartStore

9ju1Source: DShort

9ju5Source: ZeroHedge

 

Piecing It All Together

US equities have diverged from fundamentals, earnings and smart money flows for around 2 years now. In all three regards this echoes the couple of years prior to the 2000 peak. The run-up to steep valuations achieved by sharp increase in leverage also matches the run into 2000, and collectively these all indicate a speculative mania which has been historically induced into a solar maximum. Solar cycle 23 maximum = 2000, solar cycle 24 maximum = 2014.

Screen Shot 2014-06-08 at 13.55.13Source: Ed Yardeni

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Source: Fat-Pitch

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Source: DShort

At the turn of the year into 2014, I believe we began the first phase of the topping process. Nikkei peaked, Bitcoin peaked, money switched into defensives in a trend that continues, with treasuries the best performing asset and utilities the best performing sector of 2014 thus far. Such a turn-of-the-year peak fits with a cluster from history and and I believe reflects peak inverted geomagnetism: a seasonal optimism peak.

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Source: Stockcharts

8ju8Then at the turn of February into March I believe we saw the second phase of the topping process, with margin debt, Russell 2000, Biotech and momentum stocks all peaking along with the solar maximum. Such a neat confluence would echo March 2000 in all regards, and the technical price action has developed similarly since, as shown by the analogs below. If this is valid, then we should expect Biotech and R2K not to exceed their Feb-Mar peaks, and the solar maximum to wane. Like the dot-com stocks of 2000, small caps were bid up to p/es over 100 into Feb/Mar, and so by valuation, leverage, asset allocation ratios and price analog we saw a mirror of 2000; just the super-sized peak and public interest were lacking due to demographics.

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Source: Market Anthropology

Whilst small caps are off their peaks, large caps have now broken upwards to new highs. To bring us right up to date they are trying to cement a break-out on 62% II bulls, 91% NAAIM equity exposure, some 9 month divergences in breadth, low volume, low protection and low volatility. Skew remains in a persistently elevated range, reflecting the risk of a large downside move due to the extreme lop-sidedness in the markets. 1987 and 1929 (similar backdrops in sentiment, valuation, leverage) both produced breakouts from ranges around May for a final 2-month overshoot higher, so there is historical precedent, but to achieve that here and now we would need to print anomalies in some historically reliable indicators and print some new all-time records in bull assets, sentiment and, likely, leverage.

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Source: Acting-Man
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Source: Not_Jim_Cramer8ju20 8ju21

Source: Financial-Spread-Betting

I believe that US equities are more likely capped on the upside, with a lack of fuel to propel higher, in an ongoing topping process that began at the start of the year. Looking ahead to this coming week, the overbought and overbullish indicators flagging make it more likely the markets will pull back, perhaps to retest the breakout. This likelihood is enhanced by the downward lunar pressure and geomagnetic storming over this weekend.

A final topping price in the June/July window for large caps would fit with the inverted geomagnetic seasonal model above, and as per that model, could then pave the way to ultimate hard falls in Sept/Oct time. A ceiling on large caps price rises here would then likely be compatible with R2K and Biotech not exceeding their Feb-Mar highs. This in turn would then fit with margin debt pausing its decline but not exceeding its high, as it did in 2000 and 2007, whilst stocks completed their overall topping process.

In short, the above analysis is the best fit as I see it. The cap on equities moving significantly higher is key. The big picture for that is demographic, and supporting that are the levels in sentiment, leverage, volume, and asset ratios. The picture is one of very lop-sided extreme bullishness, with naked unprotected longs on leverage. Markets have historically been unable to keep advancing when indicators have reached these levels and the mature divergences now in place ought also to resolve through downside price action, short of printing historic anomalies. Such a cap on price upside would then likely honour the existing peaks in small caps and margin debt and the turn-of-the-year cross-asset peaks that continue to be compelling in association with the solar cycle peak. Drawing on the historic analogs this may mean range-trading for some weeks more yet before a sharp correction erupts.

New highs in small caps, new highs in leverage, a reversal out of defensive sectors and assets, and/or repairs to volume and breadth would make me abandon that ‘best fit’ and conclude that the sun is not yet done with its speculation incitement. Whilst I can’t rule out a more definitive, crazy parabolic to erupt here, as has been typical at historic solar maxima, I just doubt it because of the lack of demographic support combined with the levels already reached in the likes of margin debt, rydex, valuations, investors intelligence and more. If a sharp terminal up-leg can actually occur from here on continued low volume, without the need for a stream of new buyers, then it would be a game of confidence in which the fear of losing out on stellar gains drives prices higher in a feedback loop despite participants knowing it is manic and unsustainable. If that were to occur then it would make the ultimate correction even bigger, but prior to that it would be a challenge to both bulls and bears: play the danger or suffer the drawdown. What seems clear though from history is that leverage would need to accompany such rises, and it appears that leverage already peaked out. However, there is a possible middle path, in which prices can eek out some more gains in June/July whilst not straying too far and honouring most of the above.

My strategy remains the same: I continue to look and attack on the short side for both short term profits and to add to my sell-and-hold big position. Only if it appears that we are entering some kind of terminal parabolic panic-buying upleg, would I then look to hedge by joining the danger game on the long side to some degree. Meanwhile, the risk to those still playing the long side is that the market is vulnerable to some surprise bad news due to the skewing of bulls, bullishness, leverage, complacency and lack of protection.

Thursday Morning Charts

1. Bulls in control of price still, but the combined picture of this chart suggests an imminent handover to the bears:

5ju1Source: Stockcharts; Annotations: Mine

2. Plus, new high on negative Nymo breadth:

5ju6Source: Tradetrekker

3. Equity only put call ratio printed an extreme low yesterday:

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4. Investors Intelligence bullish sentiment last seen Oct 2007:

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Source: Charlie Bilello

5. Sornette bubble-end flagging a second time on SP500:

Screen Shot 2014-06-05 at 07.25.01Source: Financial Crisis Observatory

6. Euro short interest at level that suggests a rally ahead in the European currency:

5ju7Source: FX Street

So, ECB decision today and US employment report tomorrow. The Euro chart above potentially paves the way for ECB aggression disappointment (thus Euro rallying), which would fit with their conservative approach to date. Meanwhile yesterday’s ADP report paves the way for a potentially disappointing US jobs report tomorrow. However, if news exceeds on either release then more short covering could propel equities higher.

Pressure is downward from here into next Friday’s full moon. The combined picture, including the charts above, has set up another compelling chance here for the bears, so let’s see how the market reacts to the two news releases.

 

Fuel Spent

History in the making for the US stock market, updated:

1. Crestmont p/e valuation only exceeded in 1929 and 1998-2000

2. Q ratio valuation only exceeded in 1998-2000

3. Market cap to GDP valuation only exceeded in 1997-2002

4. US household exposure to equities only exceeded in 1997-2002

5. Euphoria and sentiment composite readings only exceeded in 1997-2000

6. Third longest bull market in history

7. Third longest duration above 200MA

8. Margin debt to GDP and net investor credit at all time extremes

9. Skew readings cluster highest ever

10. Complacency, negative divergences in breadth and negative divergences in defensive sectors/assets all resemble peaks of 2000 and 2007

These various measures collectively suggest that the bull market is mature, that stocks are expensive, that investors are all-in and that we are looking at a major top. The only bigger mania in history was 2000, which, in contrast to now, had a demographic tailwind.

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There are three ingredients for a super peak: a solar maximum inspired speculation peak, a demographic peak (new buyers buying), and a leverage peak (same buyers buying more). 2000 had all three, but 2014 lacks the demographic tailwind, and for that reason we should not expect to reprint 2000’s all-time extremes.

Over the last 18 months we have seen the requisite evidence of a speculation mania, inspired by the solar maximum. During that period we have seen the stock indices diverge from earnings, fundamentals (economic), and smart money flows, and we have seen sharp escalation in leverage (margin debt, Rydex leverage). We reached dizzy valuations in small caps, biotech and social media, and by various measures, major stock index valuations already exceeded 1929 and 1968 peaks.

On current evidence it would appear the solar maximum peaked out along with the main speculation targets around February 2014, which is also when margin debt and net investor credit balances reversed.

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If stocks were to move materially higher from here, then we would need to see an extending solar maximum, a further reversal in leverage to print new extremes, and/or a stream of new buyers.

We see evidence for the demographic headwind in shrinking trading volumes, and if we couple that with the readings in household exposure to equities, fund manager allocations, and institutional versus private buying, which suggest saturation, I suggest it is unlikely that we have the fuel for another significant move higher in ‘new buyers’.

Screen Shot 2014-06-03 at 06.34.40

I then look at the extremes, spike and reversal in leverage and it is unlikely that increased ‘buying-on-credit’ can provide the fuel for another significant move higher from here. So even if the solar maximum were to extend beyond expectations then I suggest it is highly unlikely that equities would be bid up significantly higher from here, as if this were 1928, as both ‘more-buyers’ and ‘more-leverage’ look exhausted.

Since 2014 began, relative performance of utilities and treasuries, breadth loss in equities, and developments in sentiment have all echoed previous stock market peaks. These warning signals are now mature and add to the likelihood of stocks breaking lower from here, not higher. Not only that, but the combined settings of leverage, complacency, euphoria and levitation suggest that we are on a cliff-edge heading for a sharp crash.

I’ve added short again on US stock indices as I continue to see a historic opportunity at hand, and I believe the evidence suggests there is little fuel for a significant leg higher. Rather, the evidence suggests that we are in the last gasp of a topping process.