Over the last 18 months, US equities rose on 80% multiple expansion and just 20% earnings, and they diverged from economic fundamentals.

Source: Yardeni

Institutions were net sellers in this period whilst retail investors became the buyers, typically the ‘dumb money’ and a sign of a peak.

The carry trade ceased to be fuel for higher prices.

Source: John Kicklighter

Instead, retail investors went all-in on bullish equities allocations and then leveraged up in a major way, to propel equities higher.

Source: Stockcharts

 Source: D Short

Source: Sentimentrader

We see a trend of distribution in this period, both in major accumulation days (just 1) versus major distribution days (12) and in Chaikin money flow, which suggests underlying building smart selling pressure.

Source: Ponzi World

In short, the stock market mania of the last 18 months has been fuelled by the retail crowd and their credit facilities, not manipulated by the big institutions in some sort of cartel as some suggest.

The whole process can be explained by the rise into the solar maximum, driving people to speculate.

The process is mature and here in mid-2014 we see a range of indicators suggesting termination:

1. The best performing asset in 2014 is treasuries.

2. The best performing sectors in 2014 are utilities and healthcare, the defensives that typically outperform post market peak.

3. The hot speculative targets of Bitcoin, social media stocks and small caps all appear to have topped out, with Biotech a question mark but having made no progress since February.

4. Margin debt has also made no progress since February, which remains the peak.

5. Divergences have grown in breadth, sentiment and risk measures.

6. Volume on down days versus up days resembles previous peaks.

7. Sornette bubble end has flagged and extreme Skew continues to warn of a big move to the downside.

8. The smoothed solar maximum appears to have passed around Feb/March time.

9. Valuations have reached dizzy levels, with the median stock average valuation higher than in 2000 which was more concentrated in tech stocks:

Source: Hussman

Turning to the short term, yesterday was another record ultra low volume day. Also, $SPY remained in a 1 cent range for 18 minutes, almost dead, beating a Nov 2006 extreme of 10 minutes. Indices went nowhere overall, so we roll over to today. Geomagnetic disturbance is underway.

To sum up, my bottom line is this. Whatever research angles I collate always point to the same: a comprehensive multi-angled case for a bull market peak, and not just a peak some time soon, but the last gasps of a peak that has been in progress all year. We can argue over select indicators and doubt them individually, and no-one can avoid confirmation bias. But the breadth of the indicators and differentiation of the angles make for a multi-way, cross-referenced set that is surely something objective and compelling. The evidence just does not support a bull market continuation from here nor a parabolic blow-off top from here. The evidence says we should collapse any moment, not just into a correction, but into a devastating bear market with all that retail leverage and skewed allocations unwound in a very painful way.

Clearly price is all that ultimately counts, and therefore you should maintain a healthy doubt about my case until price proves it. But, rightly or wrongly, I still think this is it:  the stock market mania began 18 months ago; risk peaked 31 Dec 2013; the solar max, margin debt, hot sectors and indices peaked Feb/Mar 2014; and the last phase of the top was July/Aug with the Sornette bubble peak, European indices peaks and US indices peaks. I believe the current ultra-low volume double tops / marginal higher highs on negative divergences in Dow, SP500, JNK and IBB will resolve to the downside, and the devastation be reaped in September and October.

Alternative 1: The Bull Is Safe

Stocks are in a new secular bull market. This cyclical bull began from the low in 2011. The economy is recovering and we need a series of rate rises before the bull’s termination is likely. If so, the bull, right now, is faced with these:

1. Over 80 weeks levitation above the 200MA on SP500

2. Over 80 weeks with no 3% change

3. Biggest ever cluster of extreme Skew readings over the last 10 months

4. Biggest ever cluster of extreme Investors Intelligence bull-bear spread over the last 10 months

5. Lowest ever net investor credit and highest ever margin debt to GDP ratio

6. Highest ever Rydex bull-bear asset spread and cluster of fund manager equity allocations

7. 8 months of ‘risk-off’ behaviour in HYG:TLT, WLSH5:GDX, XLY:XLU

8. Best performing sectors being those defensive sectors associated with a market peak

9. Averaging 4 valuation measures the market has reached a par with the peak of 1929 in terms of expensiveness

In other words, this market needs a reset to continue. The duration and magnitude of these indicator extremes mirrors 1987. The market is a mean-reverting mechanism and like an elastic band it will snap back. Therefore a significant reset is on the cards, and every day it has gone without a washout correction has stored up a major correction when it occurs. Therefore, even if the market were in a secular bull heading much higher, it is over-ripe for a cleansing. The maturity of the divergences and readings suggest the inverted geomagnetic seasonal downtrend from August to October is the most likely window for that to occur. The secular bull break outs post 1930s and 1970s also saw a reset shortly after breakout.

Alternative 2: The Terminal Melt-Up

Stocks, although stretched, are heading for a blow-off top. The kind of unsustainable trajectory that everyone knows can’t last but no-one wants to miss out on. A crazy rate of ascent to crazy valuations, and then ultimately an even more devastating pop than stored up currently. Like the Nasdaq in 2000, the Nikkei in 1989, the Dow in 1929. Although neither a demographic peak nor an economic boom peak like those three events, the combination of QE, low rates and a goldilocks economy (neither too hot nor too cool) provides different ingredients for the same kind of mania result.

(Understand, I disagree with a lot of what I am writing in these first two alternatives, I am just presenting the opposition).

The most likely candidate for that currently is the Nasdaq 100, which is the most parabolic of the indices. I’ve labelled the chart to show a potential mirror with the action in 2000 and where we might be:

Label (1) in both periods shows a first burst to what participants expect to be the peak, only for a running correction (2) to give way to an even steeper final termination leg higher (3). 5 months of crazy gains from ‘Here’ would take us to a January 2015 peak, which fits well as the other inverted geomagnetic seasonal peak of the year. If the index did break into the kind of terminal velocity of phase (3) then, make no mistake, it would be the biggest stock market mania ever, because to accomplish it we would see the highest ever valuations, leverage, allocations, sentiment and more.

Apple is the dominant stock in the Nas100 and as shown it has just made a potential breakout on the monthly view above its 2012 high:

If Apple can finish August by consolidating this breakout, then it could be set for further gains in clear air above, leading the Nas100 higher. If Apple is repelled this week, it would keep the double top option in play.

Alternative 3: The Bull Market Ends Here

As you know this is my favoured option and I have detailed my case for this many times over, so if you are new to my site, read back through a few recent posts.

This is the alternative to which all the evidence fits the best. Valuations and demographics show us to be at a cyclical bull peak within an ongoing secular bear, whilst the list of indicator extremes and divergences are features of a major peak, rather than anomalies in a bull market.

In the same way as for alternative 1, the stretched elastic band that those indicators depict means a period of heavy selling will feature in the erupting bear market, and the maturity of the indicator readings and divergences imply their satisfaction is likely very close at hand, in the period Aug-Oct 2014. Therefore, I would argue that alternatives 1&3 are similar in offering likely >20% bear gains imminently, whilst alternative 2 is the threat to my bearish stock-indices positioning.

If alternative 2 fulfils, then, because of the demographic headwind, it will require all-new levels of leverage, equity allocations and skewed-positioning. In thin volume, like in 1937, a smaller group of participants has been able to rally the market to the current level by taking Rydex and fund manager allocations, margin debt and net investor credit to beyond those previous major peaks. In all 4 of those measures we already exceed the biggest mania of all time, 2000. So, with less people available to buy the stock market, the only way to achieve the current market highs has been to stretch individual positioning and leverage to record extremes.

All the big blow-off top stock index manias of the past required leverage to rise into the peak. Therefore, with margin debt having so far peaked out in February, one important development would be that leverage peak being taken out. Tying in with that we would see various speculative targets break upwards. Expecting margin debt to be down in July, due to indices being down in that month, this last week in August becomes key, and we enter that with various investments showing obvious lines in the sand.

If IBB’s bubble has burst then it should tip over here under negative divergence. If not, it should break upwards and re-take the March high.

If JNK’s collapse in July was a true warning, then it should break down again here. New highs would invalidate.

The SP500 will either tip over here with a marginal higher high on multiple negative divergences, or it will ignore those indicators and cement an upward breakout.

The Nasdaq indices are also operating on very clear divergences:

I believe the next 2 weeks will be highly revealing. It is the lunar negative fortnight and indicators argue for a retreat. DeMark sell signals were reached at the end of last week, whilst today is the new moon and the last likely seasonal peak of mid-year. If stocks retreat from here it will make the SP500 breakout a fakeout and Dow will put in a lower high than July. The February/March peak in speculative indices and sectors and margin debt will likely be maintained. All those indicators that have been screaming ‘correction’ will move further towards validation.

If, on the other hand, stocks rally this week and next and various speculative measures break or cement upwards, then the melt-up alternative will gain weight. At that point I would consider stopping my positions, moving aside and waiting, because it would put great doubt on the epicentre of the top as the speculation peak of Feb/Mar with margin debt, IBB, SOCL and RUT.

Some further charts to consider:

The Nasdaq chart above shows advance-declines have diverged. But NYSE advance declines continue to rise in line with the SP500. Does it need to diverge too before we see a proper correction? The chart below shows a divergence into 1929 but a simultaneous peak in 1937 and 1946. With other breadth divergences in play in 2014, I’m not convinced it does.

The Sornette bubble end flagged in July 2014, but the peak nominal level of DS LPPL reached so far is lower than for previous major events:

As the three historical charts show, the ultimate market peak was always accompanied by a spike in DS LPPL, just not necessarily the highest spike. That means either July was the ultimate peak, or stocks are heading higher and we will see another spike in DS LPPL ahead, probably to a higher intensity level.

Is the global economy chugging along nicely? Germany, Japan and Russia GDP readings came in negative for Q2, France flat. China’s housing market is dropping sharply:

Global leading indicators predict a growth peak at the end of Q3. Therefore, although the US has produced some recent good data, that may be about to roll over, and data from the other majors in turn worsen. Deflationary trends are strengthening again in 5 year break-evens and in commodities:

With Europe on the cusp of deflation, waning commodities prices may provide the tipping point.

I would argue that those who believe we need to see a series of rate rises before the bull ends are failing to see that we do not have the luxury this time. Rate rises help kill bulls because they help choke off the economy. The global economy is too weak for rate rises, the choking is occurring without them.

Lastly, there has been some debate about the validity of the high CAPE valuation for the market. So here is 5 year, rather than 10 year CAPE, produced by J Lyons as an alternative:

It still shows us having reached the same overvaluation as the 1929 peak, and this is echoed in Doug Short’s aggregate of 4 valuation measures:

Which brings me back to alternative 2, the melt-up. Can we really challenge the biggest mania of all time without a demographic tailwind nor a booming economy, and from already-record leverage, sentiment and allocations? I find that extremely unlikely, but if we really can, then we surely equally see the biggest crash of all time as that is unwound.

Instead, the evidence supports us being in a 1937 peak to the 1929 demographic/economic peak (1929 being 2000 in this case). 1937 did not see a parabolic blow-off, but rolled over with sufficient disconnect between valuations and the economy.

The evidence still supports us being here in the last gasps of a topping process that began Dec 31st with a peak in risk, then followed with a speculation peak in Feb/Mar, then a final peak in July. European indices appear to have decisively broken down, and US small caps are some way from their highs. The Dow broke down from its 2014 wedge in July, and volume has been very thin in US equities on this August rally back up. I have outlined my lines-in-the-sand above and see the next 2 weeks as the crucial confirmation or invalidation.

An important week this week: more big earnings, first Q2 GDP release, FOMC and the last week of July.

Stock price increases the last 2 years have been 80% multiple expansion, front-running an anticipated return to ‘normal’ GDP growth of around 3% and earnings growth of around 10%, which has yet to occur. Stocks are now at historic overvaluation by any measure apart from forward p/e, which is based on such expectation rather than the reality-to-date. Demographics and debt tell us such normalisation is in fact not going to occur this time, and when stocks have reached these valuation levels historically, they have always tumbled into a bear market.

The earnings growth rate for each quarter of 2014 was initially estimated at 10%. Q1 came in at 2.2%. Q2, so far, has come in at 6.7%. Qs 3&4 are still pitched at 10%, but for Q3 so far, 32 companies have issued negative EPS guidance and 15 positive. The message is expectations for earnings are still exceeding reality. Even though Q2 earnings have so far been better than Q1, they do not meet requirements, and stocks have struggled to advance in July. The implication is Q3 and Q4 would need to deliver serious bumper earnings to sustain the bull market.

The lack of realism extends to the economy. Q1 GDP came in at -3%. That means Qs 2,3&4 need to deliver 5% growth each to hit the 3% averaged annual. Yet data items already released for Q2 have caused analysts to reduce their forecasts for Q2 GDP to 3% average. If that is anywhere near the reality, then as per earnings it implies Q3 and Q4 need to be bumper, to keep EOY on track. Yet as things stand, leading indicators predict growth to peak out in Q3 and economic surprises continue to weigh negative. Jobs are improving but they are a lagging indicator.

Source: Ed Yardeni

Why are many analysts and economists stubbornly unrealistic about earnings and the economy? I suggest they don’t understand the role of demographics and the unprecedented collective demographics downtrends in the major nations, which are preventing the return to ‘normal’. Historically, we typically saw the economy heat up by this point leading to a rate tightening cycle which played a role in terminating the bull market in equities. Central banks don’t have the luxury this time – no rate rises are possible as the weakness persists. The tightening is in the form of QE tapering, as rates have been made redundant as a tool.

The low rate environment is touted as a positive for equities, that valuations must be considered relative to rates. Yet as Schiller says, low or high rates have not historically affected the predictiveness of CAPE. Similarly, I have pointed out before that in the 80s rates were at historic highs yet investors marched in to equities due to low valuations, and 1937 is a good mirror to now where high valuations and low rates gave way to a bear.

Another misperception is that we in a secular bull market in equities since the SP500 decisively broke above its 2000 and 2007 highs in 2013; that valuations washed out sufficiently in 2009 as a secular low; and that as we have yet to go even begin the series of interest rate rises that will eventually choke off the economy we have fuel to keep rising until 2016 or so.

Firstly, net of inflation the SP500 is still beneath its 2000 peak.

Secondly, secular bulls and bears are always demographic bulls and bears, and the message is that we are still very much in a long term bear that began around 2000:

Thirdly, valuations have a long way down to go before washing out to historic norms:

And, as already covered, central banks do not have the luxury have a series of rate rises.

Margin debt has been released for June, and in keeping with the bullish breakout in equities in that month, it rallied. July so far has been overall flat in the markets, hence an important last few days of the month this week. Barring a significant bullish breakout, I would not expect margin debt to exceed its Feb high in July, which would keep the topping epicentre as Feb/Mar. But the sharp increase in margin debt in June has made that more critical.

Source: DShort / UKarlewitz

I suspect tomorrow’s Q2 GDP print is going to be the key. As things stand (see last 4 posts) the evidence supports a top being in in equities, which implies disappointment in reaction tomorrow and ultimate breakdown in this Dow wedge:

Two quarters earnings data and two quarters GDP data may provide the tipping point in perspective on equities rather being simply extreme overvalued rather than front-runners of a strong recovery. If equities break down the last few days of July it will make a key difference on many charts.