Last week saw the main stock averages continue their upward price run with the S&P 500, Dow Jones Industrial Average and Nasdaq all posting all-time record highs.
I mentioned in a previous article the possibility of a blow-off top for the main indices later leading to a sharp correction.
The way it stands, markets have been on an impressive winning streak and have not experienced a 20% correction in 1400 days, one of it’s longest streaks.
— Steve Burns (@SJosephBurns) February 15, 2017
Monthly charts show that the indexes (especially the Nasdaq) are entering into an extreme overbought, parabolic phase. A phase that I have warned about many times before.
Market valuation measures such as Shiller CAPE and market cap-to-GDP are in extreme categories and investor confidence is at new highs.
As well as these signals, I have noticed a plethora of new low volatility strategies entering the market in recent weeks.
Such strategies are now classed as ‘easy money’ and another signal of over-exuberance. Many are likely to fail as soon as we get a decent pullback.
US stock markets look increasingly like a bubble and as we know with bubbles, the bigger the bubble gets the bigger the pop will be.
It seems that Goldman Sachs chief equity strategist agrees saying ‘financial market reconciliation lies ahead’:
“We are approaching the point of maximum optimism and S&P 500 will give back recent gains as investors embrace the reality that tax reform is likely to provide a smaller, later tailwind to corporate earnings than originally expected.”
According to Peter Schiff:
‘The Federal Reserve has acted so slowly in increasing interest rates because they know another crisis is coming and they just hope they do not get blamed for it.’
This seems to ring true. Unfortunately, it is the relaxed attitude of the Fed that is helping to fuel the upward rally.
An awful lot of people are long stocks and bears have been severely punished for taking the other side.
However, it only takes a slight wavering of belief for the cards to come crashing down. All it takes is a bit of news or a small drop in momentum and some selling will naturally take place.
As soon as some investors sell, we are likely to see a rush of profit taking as investors try to cash in on their gains. The big question will be whether the market will get bought on the dip (as has been the norm) or whether we will see the beginning of a new bear market.
I would not be surprised to see the market open on a gap down one morning (sometime within the next couple of weeks) which then leads to the start of a 15-20% pullback. What happens after that is unclear.
Thank You For Reading
Joe Marwood is an independent trader and the founder of Decoding Markets. He worked as a professional futures trader and has a passion for investing and building mechanical trading strategies. If you are interested in more quantitative trading strategies, investing ideas and tutorials make sure to check out our program Marwood Research.
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