Market at Extremes!

, Market at Extremes!We are way overbought. We are recommending our active trading clients to go to at least 50% cash or preferably higher. We are not saying this because we fear a significant downturn in the market. There is not much risk to see in strong economic data and geopolitical risks are rather muted at this point. But we are simply making the case that we are overbought. Every signal we track is overbought. Way overbought. Plain and simple. And history is not on your side when relative strength indicators are stretched out to this extreme. Let’s take a look at some indicators that we watch.

  • The S&P 500 is 8.80% above its 125-day average. This is further above the average than has been typical during the last two years and rapid increases like this often indicate extreme greed.
  • The 10-day moving average of CBOE Equity Put/Call Ratio closed at 0.57 yesterday and will likely move further lower when reading is updated tonight after hours. Anything below 0.60 means you simply do not have enough bears in option market. Way too many people are long calls, not enough insurance is being bought.
  • The % of stocks in entire NYSE trading above the 50-day moving average closed last night at 765, which will probably rise to 80% by close of markets today. This history is simply not in favor of bulls when this indicator is above 80%.
  • Similarly, the % of stocks in the S&P 500 index trading above the 50-day moving average closed above 80% yesterday. Will likely see 83% or higher after today’s close. Almost every time this indicators is stretched out the way it is currently, we have seen either a pull back or at least sideways congestion.
  • The US entire market New Highs minus New Lows closed at 2221 yesterday. Will likely see 2400+ today after market close when reading is updated. Anything above 2000 signifies overbought conditions.
  • This sentiment survey produced by American Association of Individual Investors (AAII) that came out on January 10 (updated each week on Wednesday) showed bullish percentage at 48.7%, highest in 7 years. The historical average is 38.5%. Bearish percentage fell to 25.1%. Since this reading the Dow Industrial Average has added another 400+ points to upside in last 2 days.
  • The CNN Fear/Greed Index as of this writing is sitting at 79 and anything above 70 reading is classified as “Extreme Greed” and reading above 80 has almost always led to market correction.
  • Junk bond demand is surging. Investors in low quality junk bonds are accepting 197 basis points in additional yield over safer investment grade corporate bonds. This spread is worse than recent levels and suggests that investors are becoming more risk averse.
  • Stocks have outperformed bonds by 585 basis points during the last 20 trading days. This is close to the strongest performance for stocks relative to bonds in the past two years and indicates investors are rotating into stocks from the relative safety of bonds.
  • VIX has grounded to halt at 10 or under. Sitting in the dumpster. As a reminder, the value of VIX is determined by collect put buying vs. call buying in SPX futures as well as SPY. Basically nobody is buying insurance here.
  • And lastly, the S&P has now gone 430+ days without a 5% correction, the longest stretch in the history of the US. The prior 5 longest stretched topped out near 380 days.

The bottom Line – We are overbought in every single indicator that we follow closely and the history is simply not in your favor when everyone is cornered on one side to such extremes. If we miss the next 100 points to upside in S&P, it is not the end of world. Investors will get better opportunities down the road when there is panic and blood on the streets.