by Troy
Small speculative markets continue to explode higher while large cap markets rally less.
Summary
Here’s how I approach markets based on 3 different strategies & time frames.
- Short term trend followers should continue to ride the rally because no one knows exactly when it will end. If you are a short term trend follower, you must use stops.
- Medium term contrarian traders should go neither long nor short. Wait. Risk:reward doesn’t favor long positions right now, while shorting into a speculative rally can end in disaster.
- Long term investors should be highly defensive right now. This speculative bull market may last another 6 months or even 9 months, but in 2 years time, long term investors will be glad they did not buy today.
Bottomline: trend is up, but beware of mounting risks.
Let’s keep our mind open to different outcomes by looking at both bullish and bearish factors.
Who is buying?
A day can’t go by without another multi-billion dollar IPO exploding higher. But while traders and investors are buying small & speculative stocks like there’s no tomorrow, almost no corporate insiders are buying their own stocks anymore. The corporate insider sell/buy ratio’s 50 day average is at the 2nd highest level ever. It was only exceeded by 2007:
In 2007, stocks rallied for another half year before an epic collapse began. This isn’t to say that “today is just like 2007”. The future is never just like the past. But even if we look at less extreme historical cases, the next 3-6 months saw mediocre returns for stocks:
Beware of risks like this, but also remember that the short term trend remains UP.
Momentum
Small caps and emerging markets continue to surge higher. Bloomberg publishes a “Fear/Greed” indicator, which is really just a momentum indicator (price drives sentiment). This Fear/Greed indicator for emerging markets is at the highest level since 2007:
This may seem scary, but Bloomberg’s Fear/Greed calculation is based on NOMINAL numbers. So as the market goes up over the decades, this figure will naturally become more and more extreme. Hence, it’s better to divide Fear/Greed by the market’s value:
Here, we can see that the adjusted Fear/Greed is high, but this wasn’t bearish in the past. When emerging markets’ momentum was this strong, they usually rallied further over the next 3 months:
This is a bullish reading for emerging markets.
Breadth
Breadth is very strong across the world. The % of NASDAQ stocks at a 52 week high continues to increase:
Such strong breadth readings were bullish for the NASDAQ over the next 9-12 months:
While it’s important to focus on the trend, it’s also important to beware of mounting risks:
Speculative signs
Everything small and risky is soaring right now. An index of the most shorted, most leveraged stocks saw its 14 week RSI explode higher. The last 2 times this happened led to sharp corrections in these risky stocks:
It’s easy to see why investors are plowing into risk. Central banks are flooding the market with an ocean of liquidity:
The everything rally
As I noted on Tuesday, stocks are rallying around the world. The average country’s stock index is 18% above its 200 dma! This is the highest reading in over a decade:
*I calculated this average using the following countries’ indices: U.S., Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, HK, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, UK, Brazil, China, India, South Korea, Mexico, Taiwan, Russia.
When so many stock markets around the world surged in the past, the S&P 500 (which accounts for half of global market cap) usually rallied a little more over the next 3 months, followed by a sharp pullback 6 months later.
High volatility is to be expected in the coming months. The overextended rally can overextend even further, but nothing lasts forever.
Looking more closely within the U.S., micro-cap stocks (the smallest of stocks) are now more than 40% above their 200 day moving average! The last time this happened was in February – March 2000, near the peak of the dot-com bubble.
It’s important to note that this also happened during the first year of the 2003-2007 (September 2003) and 2009-2020 (September 2009) bull markets. In those 2 historical cases, the stock market rallied another 4-6 months before major corrections began. This is a bearish sign for spring & summer 2021.
Gamma Exposure
And finally, Gamma Exposure recently hit a record high. High values are bearish and low values are bullish. It’s better to look at Gamma Exposure as a ratio vs. the S&P 500’s value:
This is a bearish reading. When this happened in the past, the S&P fell -7.3%, -7.9%, and -31% over the next 2 months from where the S&P was as of that date:
Conclusion
- Long term investors should be highly defensive right now. This speculative bull market may last another 6 months or even 9 months, but in 2 years time, long term investors will be glad they did not buy today.
- Medium term traders should go neither long nor short.
- Short term trend followers should continue to ride the bull trend because no one knows exactly when it will end.