Are we at a bear market bottom in equities? Take a look:

1. Cash holdings of fund managers like the major stocks lows.

Source: U Karlewitz

2. Short Interest like the major stocks lows.

Source: PFS

3. Capitulative Breadth in mid-October like major stocks lows.

(CBI by Rob Hannah)

4. Volatility drops like the major stocks lows in 2008, 2002, 1990 and 1987.

 Source: Dana Lyons

5. And yesterday the Vix put/call ratio reached the same level as the major lows in stocks in 2011 and 2010:

Source: Ycharts

How could this occur as stocks reached all time highs yesterday? And how do we square all the above indicators with contrasting bull market topping readings in valuations, leverage, sentiment, allocations, dumb money flows, sector and asset rotation and others (all documented in detail on this site)?

One thing should be clear. We are not at a bear market bottom – we are at all-time highs, the very opposite. So in line with readings on some other indicators, we are in the realm of the unprecedented.

Look again at the first chart: fund manager cash. Note how it moved inversely to stocks until the start of 2013. After that, cash rose steadily as the stock market advanced. Same for the second chart of short interest: generally inverse to the market but not as of 2013. In that same period, institutions have been sellers whilst retail and buybacks have propelled prices higher, so maybe this accounts for what we are seeing.

Look, if you want to take a bullish view on the all the above, no-one can argue against you. In the realm of the unprecedented, the implications of these readings will only be clear with hindsight. But, drawing all market disciplines together, my take remains that the most likely outcome is that we are heading for a steep and swift crash. All the terrific imbalances in the market, both in levels and durations, I believe are most likely to be resolved with a major reset. It’s either that or we are now in a new normal in which many traditional indicators no longer have validity. I don’t buy that.

Yesterday was another painful day, but the clues that a reversal is close at hand remain. Small caps and junk bonds declined again, defensive sectors outperformed, negative divergences persist and gold miners advanced again. Recall gold miners popped out of the top of their topping megaphone formation in 2011, only to be swiftly reversed with a long tailed candle to the upside. So I am looking for something similar. Maybe we have to wait until the weekend’s new moon, we will see. But, the lop-sidedness in the markets is more extreme than ever, when we look at Vix, Rydex, II&AAII and ISEE p/c all combined.

Lastly, here is sentiment over allocations which reveals stock market mania, tying in with the sunspot maxima.

By various indicators, equities in 2014 align well with the last solar maximum year of 2000.

The topping process began in January. The solar maximum occurred in March with an associated speculation peak (margin debt peak, speculative target index peak with p/e>100 (Nasdaq in 2000, R2K in 2014)). A double top occurred in July and September, and an initial washout low in October (capitulative breadth spike >10). All this is captured in these two charts, using the Dow Jones World Index:

Source: Stockcharts

The July/Sept double top in price was higher in 2014 than the March peak (vs. lower in 2000), but the indicators reveal the topping process proceeding in the same way since the turn of the year.

We can see the top performing sectors align (defensives signalling a market peak):

Source: All Star Charts

Source: Macromon

The extreme high banding in allocations aligns too. The October capitulative low failed to wash this out, just like in 2000.

Indicators position us equivalent to October 2000 (and January 2008 if we tie in the 2007 peak). Subject to how October closes, the monthly candles look similar:

The long-tailed candle, rather than being a bullish development, instead appears as the first evidence of real selling befitting the end of a topping process. That makes the rally a rip to sell.

The candle comparison unites with the positioning by indicators (solar max, topping process, margin debt, breadth, treasuries, sector performance, allocations), so it seems right. A negative November looks to be on the cards.

Another surprising day. Strong bullish action in US stock indices with leadership by cyclical sectors and small caps putting new highs within reach on most indices, and actually achieved by Dow Transports. The monthly candle on TRAN is something to behold, fairly unprecedented in the last 2 decades.

Source: Northman Trader

Ditto on the other US stock indices, which makes drawing on a historical analog for guidance difficult. With 3 sessions left in October, we would need to see a significant reversal to negate this current candle. Should that not occur, then I have to allow for the prospect of a continued bull market into year end, given the seasonal tailwinds, breakouts in Biotech, Apple and a decisive move back upwards in the R2K. However, I still rather see the weight of evidence as supportive of the wider markets having peaked, putting us in the early stages of a bear market.

European indices show a fairly clear lower high and lower low, and the October rally looks like a relief rally and nothing more:

 Source: Stockcharts

Turning to the US, here is the Dow (Industrials). We can see clear divergences in breadth and the Vix that still suggest we may have indeed made a switch from bull to bear at the start of July, but the price action is nowhere near as clear cut.

The trajectory of the October rally is powerful but unsustainable. Nymo over 80 is a measure of how overbought we have become and previous such occurrences shown below led swiftly to significant reversals 8 times out of 9:

Source: Jack Damn

Therefore, the rally ought to reverse today or tomorrow and the FOMC output may provide the trigger.

Credit spreads have not confirmed this rally and are also showing a peak at the start of July:

Source: Michael Gayed

Nasdaq breadth diverged significantly at the same time and remains non-confirming of the October rally:

An overall topping process in equities still appears to have begun at the turn of the year, with various angles on this:

Again, there has been little repair from this powerful October price rally.

Skew remains in an extreme high band since late 2013, warning of an outsized move in price.

Source: Barcharts

Investors Intelligence sentiment has been in a similar extreme high band over a similar period. Ditto Rydex allocations:

These are all particularly mature flags now.

The key question is whether US stock indices can rally to new highs here and squeeze the bull market into year end. I have kept this as my worst case scenario for some time. Given the mature divergences and topping indicators that have been in place since the turn of the year, it remains questionable that they can extend that far. When we add in the additional non-confirmations that have been in place since the start of July, the probability further shrinks. However, given the breakouts in certain stocks, sectors and indices and the power of the October rally, I have to respect that it could happen.

The sharp rise in the Vix into early October and the subsequent collapse is unprecedented in speed, magnitude and reversal. Like the monthly candles on the stock indices we don’t have a mirror from history to guide us. If we are set for decisive new highs in stocks then I believe it will be clear with hindsight that the solar maximum was not through yet. If so, maybe that October spike in solar flux holds some weight:

Source: Solen

For now, the weight of evidence still supports the smoothed solar max being behind us, along with the speculation peak in equities. The weight of evidence supports a topping process in stocks that began at the turn of the year and peaked in early July, and a bear market being in progress since then despite wild oscillations in price. If instead price can make new highs here (in US large cap indices), then indicators suggest that much like the September marginal highs they should be short-lived. However, given how overbought the rally has become, it appears likely that price should retreat before this week is out, which would likely create the missing lower high in US large caps. After that, we would then turn attentions to whether price can base above the October lows.

My opinion on today’s FOMC is that it will be a market mover, and that they will stick to their QE exit. It seems the likely point for the markets to reverse back down, in a sell-the-news scenario, but given the power of the October rally, we will just have to see. Either way, the power has generally been in price, not in health. I see no reason to be bullish here unless many of those indicators and divergences can be repaired. However, we are once again at a crunch point, as this is about as high as we could expect for a ‘second chance’ lower peak. We have currently retraced 83% of the October falls on the SP500, exactly like the 1937 second chance lower peak. That, plus the Nymo and FOMC provides a set-up for a reversal here. No change in my positions until we see if that materialises.

The most common idea I’m reading on Twitter currently is that the current stock market correction is an echo of July 2007, implying a rally back up to marginal new highs may be next. However, these traders are mistaken in where we are in the topping process.

Comparing 2000, 2007, 2011 and 2014 tops, here are two measures of Nasdaq breadth: cumulative advance-declines and stocks over 200MA (the latter not available for 2000). Breadth diverges at stock market peaks. All 4 periods saw a topping process lasting around 6 months with 3 Nasdaq peaks. Over the 6 months and from the 1st to last peak we saw consistent degradation of breadth.

Source: Stockcharts

The last chart shows that here in 2014 we have also seen a 6 month topping process with 3 Nasdaq peaks and both breadth measures diverging from the 1st to the last peak. If we were now in July 2007 then we should be at the start of the topping process, about to begin the breadth divergences. Instead the comparisons put us at the end of the topping process, akin to December 2007.

Next, here is the SP500 versus three different indicators of a market peak: high yield bonds to treasuries ratio (not available for 2000), consumer discretionary sector to utilities ratio, and Dow-gold ratio. They also all typically diverge during a topping process, showing an underlying shift to defensives. Once again we see in all periods the 3-peaked 6-month topping process, and the divergences beginning at the 1st peak and completing by the final peak.

The last chart shows 2014 has produced an anomaly in the Dow-gold ratio (it is flat, rather than down, for the year), but the other two indicators mirror the previous peaks, and again their progression would put us in December 2007 not July 2007.

I’d like to stress I don’t think 2007 is the best mirror (in case you are now studying the action post December 2007). 2000 was a solar maximum like 2014, and shows marked similarities in Rydex and Q-ratio, amongst others. I have made a case that 1937 is the most appropriate mirror from history, but most indicator data does not stretch back that far. Rather, my aim here is to disprove the idea that we are at the beginning of a topping process.

Next, here is margin debt. Whether we measure from real margin debt peak to real SP500 monthly peak, or from nominal margin debt peak to the end of the nominal topping process (the third peak), the range is between 3 and 7 months from margin debt peaking to the market beginning major declines in earnest. So it is another leading indicator, or divergent during the topping process.

Source: DShort / My annotations

In 2014, margin debt peaked in February and given market declines in September and October we can be confident that peak will continue to be honoured. This again makes a case for stocks now being at the end of the topping process, tipping into the major declines.

And lastly, NAAIM manager exposure to equities is also doing the rounds on Twitter currently, due to the latest reading having sunk to 10% (note this chart below is from 4 Sept so I have added the latest reading). The chart shows that NAAIM is smart money, or again a leading indicator / divergent during the topping process.

Source: Acting-Man / My annotations

The period of divergence in 2014 echoes that in 2007. Once again, this suggests we should be at the end of the topping process, not the beginning. We can see that NAAIM actually went negative in the corrections of July/August 2007 and Sept/Oct 2011, so lower than +10% is possible, but rare. We can also see that in January 2008, just after the topping process completed in December 2007, NAAIM dropped sharply to just over 10%, and this in fact reflected the true start of the bear market, rather than a washout buying opportunity. Given the other indicators above would also position us in January 2008, and around 40 indicators called a bull market peak this year, then this is also most likely the tipping point into real bear market declines, not a buying opportunity.

Finally for today, just a quick note on the 64-month bubble idea (this article). Cal referred this latest update to me and WT suggested the same conclusion that I will. The writer claims that bubbles last 64-65 months from start to peak. Having done my own calculations, I argue he has used some artistic licence, because the range of his examples are rather from 36-85 months. Various start dates that he has used are highly questionable. Nonetheless, if we give him some leeway then the range could be tightened up to perhaps +/-10 months around 64, and this broadly fits with the period from solar minimum to solar maximum, or from a speculation low to a speculation peak. Some of his examples are exactly that, e.g. the Nasdaq into 2000 or the Nikkei into 1989.

Source: Solen

He doesn’t have a compelling reason for why bubbles would last 64 months, and that’s not good enough for me. Whatever the discipline or angle, I want to see a correlation and a scientific or logical reasoning for it.  So in short, the data suggests a range for bubble durations, making his quote an average at best, and it fits the solar cycle duration, for which we have evidence of biological effects on humans that cause fluctuations in excitement and speculation. Ultimately, trying to time a peak using a 64-month calculation is likely to fail.

To the markets short term. Yesterday produced a doji candle in US large caps so we roll over to today. The balance of evidence still suggests we are post-second-chance, or post-3rd-and-final-peak in the above analysis today. Therefore, there should be no rally back up towards the highs and I believe we will soon engulf Wednesday’s candle to the downside.

What today’s analysis shows is that the anomaly is in price here in 2014, in that the July and September highs were higher highs in the SP500 and Nasdaq, making for what looks like an uptrend rather than a 3-peaked topping process. But in fact the behind-the-scenes indicators reveal the topping process and that those September highs are equivalent to September 2000, December 2007, or July 2011. Much later in the topping process than many analysts think. What’s also important to note is that those three topping processes all involved a decent correction during their formation, whilst in 2014 a meaningful correction has been avoided until now. That implies we have stored up a mega-correction, and this idea has support from indicators such as Investors Intelligence, Skew and Rydex which have been held at major extremes this year, like highly stretched elastic bands. Therefore, not only are we now most likely already in true bear market declines, but there is a strong likelihood of a crash akin to 1929, 1987 or 2008 at the centre of those declines. Most analysts are going to be completely wrong-footed by what transpires.

Recall that Rydex, margin debt, loan issuance, Investors Intelligence, fund manager allocations, household allocations and other indicators collectively revealed a situation of stock market participants being all-in on equities with totally lop-sided portfolios and having taken on as much borrowing as they could to further invest. Maximum speculation as generated by the solar maximum. I referred to his before in trying to gauge ‘fuel spent’ for the stock market, as it strongly looked like we had reached saturation.

Now here we are in Q4 2014 post-solar-maximum, with people unwittingly less keen to the buy the dip, and even less so at the seasonal geomagnetic sentiment low of October. We saw a change in market character in September, at which point I believe the smart longs got out. The falls in October to a lower low and sub 200MA cemented the new reality and the next level of players exited. The next development I believe is that we see no rally back up towards the highs but instead collapse further and sharper, at which point the remaining dumb money will be scrambling for the exits, resulting in a crash. Because, the point is, all those indicators collectively showed that we had reached effective market saturation: no bears left to convert, no more fuel to buy, and tremendous lop-sidedness. With a demographic headwind, the market needed the steep increase in leverage to push it higher, but this has to be fully repaid and history argues by way of forced redemption panic selling. Who will step in to buy and shore the market up? All those indicators plus collective demographics in the major nations suggest the queue to buy the stock market is now fairly empty. Therefore, the current trickle over to the bear camp, to selling and shorting, has very little counterbalance. Stock market declines should therefore come easy, and once the trickle becomes a flow, the market should accordingly crash.