It Doesn’t Make Sense, but Don’t Fight the Tape

The S&P500 inched up another 0.87% last week, on abysmally low volume, meaning that there is very little conviction behind the buying. In fact the volume was so low that it resembled what you’d normally see around the winter holidays, not a typical summer week. Adding to the concern about the lack of volume is the utter lack of volatility. The VIX index fell to a multi-year low last week, and this happened in the face of a slew of building global risks—a hard landing in China, continued recession in Japan, a broad and deepening recession in Europe, and now a slowdown in sales and earnings in the US.

The players in the equity markets appear to be saying “what, me worry?” as they blissfully continue to march prices higher. On Wall Street, traders are openly admitting that the steady move higher “makes no sense” but then they add “don’t fight the tape”, which means that they admit that prices should not be moving higher, in the face of all the evidence, but since prices are moving higher anyway, then a good trader must simply accept the situation for what it is and join the party.

The thinking is that if, or when, the party ends then a good trader will have plenty of time to find the exit before any big selling begins.

The problem with this thinking is that NOT all traders, good and bad included, will possibly be able to exit the party before the big selling begins. Inevitably, most will get trapped and suffer big losses.

So the best analogy to today’s price action and to those traders playing the game is picking up nickels in front of a steam roller. The upside rewards are small (nickels) yet the downside risk is huge (getting caught and crushed by the steamroller).

Good luck to those who choose to play this game with the bulk of their money.

In the meantime, most sensible investors are just saying no to the rigged casino. For the third consecutive year, investors have been pulling more money OUT of the stock market than IN. Yet even though stock prices have been climbing higher, it seems that the average investors are sticking to their guns and refusing to jump back into the manipulated stock markets, preferring to put more money into bond funds, money market accounts and even simple bank accounts.

Technically, the stock market remains highly overbought on the daily charts. Breadth is not strongly positive. And upward momentum, although still in tact, is weakening. Conditions like these typically do not last for very long and call out for a strong pullback.

Overall, the market temperature is very warm. P/E multiples have been expanding lately, holders of equities are not rushing to sell, credit spreads are very tight, and overall capital is not difficult to get.

This translates into a current market environment where prospective returns are low and—at the same time—risks are high. Without making any projections about the future, it reasonable to argue that today is NOT a favorable time to be hugely exposed to US stock markets.

The timing of any possible pullback is impossible to predict, but the likelihood that a pullback will occur is high and rising, rising every time the US equity markets inch higher.

Be careful.

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