Extremely stretched valuations, highly lop-sided sentiment and allocations, excessive leverage, long-standing negative divergences, persistent shift to defensives, negative leading indicators, disappointing earnings, declining financial conditions: these are some of the ‘old’ rules that dictated stock market peaks. Yet, many months in their presence, equities still haven’t dropped in any meaningful way.
Looking at the SP500, there has been no fall of even 10% in the last 2 years.
Source: Rachael Shasha
Yet those indicators/rules would historically dictate a fully-fledged bear market. Add in the smoothed solar maximum timer, which now looks fairly definitively April 2014, and the continued levitation is even more surprising.
Do the old rules still work? I still believe they have to. There are too many different angles amongst them for them to now all be redundant, even with central bank intervention distortion. But this really feels like the last chance for them to hold.
A selection of global stock indices shows what may turn out to be a long distributive topping process, if this isn’t to be a consolidation by time.
A selection of risk-off negative divergences in play for a year would echo this:
If we argue the correction or ‘bear’ has been by time not price then such indicators would now be poised to break upwards again. The problem with that angle is that there has been no resetting of allocations, leverage, valuations, sentiment and various negative divergences. Corrections by time gradually neutralise such indicators to refuel the bull, yet this has not happened.
A look at breadth shows what appears to be an initial attempt at a stock market peak at the start of 2014, followed by a breakout to the upside. We have then had a second attempt at a peak in the last 6 months, but potentially NYAD is showing another breakout which would reset the topping attempt again.
This would fit with developments in European stocks indices which are breaking out and look positively bullish. Potentially, the Eurozone’s QE and improving leading indicators could keep US stocks from falling significantly here in early 2015, as we could argue the US did for European stocks in 2014.
The big picture still looks like this: a definitive trend change in major asset classes in mid-year 2014. But we need to watch to see if the up-ticking of the last week could potentially spell a break from, or pause in, the downtrend.
US economic surprises versus valuations looks like this. See how stocks largely ignored a breakdown in economic strength in the first half of 2014. Will they ignore the current trip into the negative? Also note how valuations have risen at their steepest rate since the October 2014 low: the move up in prices has been very much counter-earnings.
Draw it all together and I still have to favour the ‘last gasps of the topping process’ angle. I refer to my 3 key dates of the turn of Jan 2014, the end of June 2014 and the end of Dec 2014 as they three key milestones in this, all anchored to the 2014 smoothed solar maximum.
However, if equities (meaning US equities joining European) and indicators break upwards again, then it would raise the prospect of a final blow-off top, a parabolic termination that could perhaps take us to mid-2015. I base this on the 1929 experience post-1928-solar-max, the failed topping attempt in breadth in 2014 perhaps failing a second time here, and the geomagnetic seasonality of the markets. Something like being here (circles):
I just still find that very difficult to make a case for, given how super-stretched sentiment, allocations, valuations and leverage already are. From where is the fuel for another significant leg up?
The next few days are key. Did yesterday’s full moon mark an inversion top from which we now decline, keeping US indices from making new highs, whilst European indices in hindsight will show a blow-off top? Or do we now have a clear 2 week period of typical strength ahead into the new moon making for a comprehensive global breakout in equities? If the latter I would expect gold would be repelled downwards again.