You've Been Warned: This Is a Bear Market Rally
I've recently outlined my intermediate-term economic and market concerns in yesterday'sopener Brussels Reminds Us to Question Our Investments, my recent missive A 2016-18 Financial Crisis Lies Ahead (Part One and Two) and other columns.
But this morning, let's look at the shorter term -- and explain why I believe the rising stock prices that we're seeing are just a "bear-market rally" rather than a new bull-market leg.
After ringing up their worst start ever for a new year, the major stock-market indices have recently enjoyed a breathtaking five-week rally that wiped out all of the previous losses.
Recession concerns have disappeared as the Federal Reserve delayed anticipated rate hikes, and outflows from risk-on assets have morphed into inflows into junk bonds, equity ETFs and even emerging-market funds.
As a result, many now believe that we're in a continuation of the third-longest bull market in history, rather than just seeing a temporary rally within a broader bear market -- but I disagree.
* Previous bear-market rallies have seen the same sort of conditions that we have today -- short covering, a change in sentiment from bearishness to bullishness and a fear of "missing out" on the market's apparent rise.
* The recent rally's five- to seven-week timeframe is consistent with previous rebounds from very deeply oversold conditions. Personally, I believe the market has simply moved to an overbought extreme from January's oversold one. (Helene "The Divine Ms. M" Meisler rounds up the evidence for an overextended market in a good columnthis morning.)
* Peter Boockvar's take on the rising bullish sentiment: "The rally off the Feb. 10 low continues to bring out the bulls. According to Investors Intelligence, the number of bulls rose three points to to 47.4% -- the highest reading in nine months -- while bears fell 2.5 points to 27.8%, the lowest since December. The spread between bulls and bears is now at its widest level since August, before you-know-what. ... We [now] have a VIX down to 14, the most overbought market in 1-1/2 years according to the seven-day RSI, and now the widest bull/bear spread in seven months. Be careful chasing here."
* Although the recent advance has had some of the best breadth since mid-2009, it's also coincided with clear weakness in the number of stocks hitting new 52-week highs. The low levels of new highs are mostly due to the fact that many of the market's recent big gainers are in depressed market segments like gold, energy, materials and industrials. Contrast this with the health-care sector's struggles.
* The rebounding sectors are also quite extended and overbought now, and are beginning to show some signs of momentum loss. (The price of oil comes to mind.)
Other sectors like utilities and consumer staples also look like they're extended and overbought. Both of those are trading well above their 200-day moving averages, and might no longer represent "defensive" investments.
* The rebounding groups have benefited from a weakening U.S. dollar, but the greenback is approaching an important support level that the currency has historically rebounded from in recent years.
* As I've consistently written, leadership changes typically occur in bear markets rather than bull markets.
* The 10-day put/call ratio is down to 0.89, a level that was consistent with market tops during late 2014 and late 2015's rallies.
My pal Tony Dwyer also pointed out yesterday that:
"One additional historical data point that reinforces a correction view over the near-term comes from Dow Jones Industrial Average. As of yesterday's close, every Dow component stock was over its respective 10-, 20- and 50-day moving average. Since 2000, the only other time that happened was Oct. 27, 2011. The market topped out a day later and was followed by a 8.17% correction.
In hindsight, the November 2011 drop was the successful retest of the low, which led to the next major leg higher (+18% in four months). But similar to every other overbought correction, [it] was only considered 'natural, normal and healthy' until it happened.
Although we doubt the tragic events in Brussels are the excuse, the derivative effect of the terrorist attack on anti-immigration chatter as we approach the Republican nomination process and 'Brexit' vote in June may be enough to generate the 'pause that refreshes."
Finally, three charts that Zero Hedge posted last night serve as further evidence that we're in the final inning of a bear-market rally.
The first one shows that Wall Street's recent rise is stretched relative to the real U.S. economy:
Source: Zero Hedge
The second chart illustrates the gap between stocks and corporate-profit expectations:
Source: Zero Hedge
And lastly, this chart illustrates how the historic correlation between stock and bond prices is now very distorted: