A Slightly Ominous Development
Below we show a few stock market related charts that indicate that the recent rebound may well have been part and parcel of at least some sort of corrective period, in spite of several indexes attaining new highs. Note here that we don't care why the market reportedly fell on Thursday. No-one knows for sure whether the reasons cited in the financial press were really the culprit (allegedly, a worsening of the Russian/Ukrainian situation was to blame; but very often the excuse doesn't really matter. After all, the Ukraine situation was completely ignored so far).
First, a chart of the DJIA and the SPX for comparison purposes. The interesting thing is that the two measures have diverged at the most recent peak. Note in this context that divergences in the performance of various indexes have been increasing since the beginning of the year. That is usually a negative sign.
The DJIA turned back down before reaching a new high, contrary to the SPX, which did (most other popular indexes also reached new highs, but performance divergences have opened up further between all of them) – click to enlarge.
We realize of course that a few down days don't necessarily mean much, even if one of them was a big one. However, trading volume has declined throughout the rebound, and one could therefore interpret the action as an 'Ordian retest' (following Tim Ord's rule for retests that occur on lower volume), even though most indexes actually managed to eke out slight new highs. The fact that the DJIA did not confirm the other measures is definitely ominous. Keep in mind though that the monetary backdrop suggests that there is still enough juice out there to keep asset prices elevated. However, since it is simply not possible to tell with certainty at which point the continuing slowdown in money supply growth will actually begin to matter, one must remain alert – especially as there are many signs that we are in the middle of a veritable mania of historic proportions.
Bullish Sentiment Out of Bounds
One of these signs is evident in various permutations of Rydex fund data. As we always point out, these represent a useful microcosm of market-wide sentiment. As they represent actual positioning date, they are actually superior to surveys. Decisionpoint has its own way of representing the data, in that it inter alia constructs a ratio that compares bull and sector fund assets with the sum of bear and money market fund assets. This particular ratio is back at levels last seen in March of 2000, something we did not expect to ever witness again. And yet, here it is (h/t to Greg Schnell from stockcharts.com, who pointed this fact out in Thursday's market message):
To summarize this: the ratio of bull assets vs. bear + MM fund assets is back to where it was at the year 2000 peak. Both bear assets and money market fund assets are at the lowest level in 16 years. Bull assets are back at their 2007 peak. We have highlighted excessive 'hate' and 'love' with the red and blue vertical lines respectively. As you can see, it usually pays to take warnings from the Rydex data seriously. Right now market participants seem to be 'all in' and betting on further gains – click to enlarge.
The leveraged Rydex ratio (which measures the ratio of bull and bear assets deployed in leveraged funds) has experienced a blow-off move late last year that absolutely dwarfed anything that has been seen before by a huge margin (in fact, by a margin of 100%). It has since then retreated, but only to a level that is still above what used to be the historical extreme before this massive blow-off move.
Never before have traders in leveraged Rydex funds been more optimistic than at year-end 2013. The current level of optimism is still way above the peaks that have been recorded in the past. As an aside, a decline in optimism from totally one-sided to slightly less totally one-sided concurrently with slightly higher prices actually represents a negative divergence – click to enlarge.
The range in which the mutual fund cash-to-assets ratio has been trapped since 2010 is the lowest in the history of the data, which have been collected since the 1950s. It was below 4% the entire time (currently at 3.6%). Note that the then record low made at the year 2000 peak was actually 4.4%. Today this would be a 'relatively high' reading. Extremes are obviously no longer what they once were.
It's a good thing that neither Mr. Bernanke nor Ms. Yellen can see any signs of a bubble anywhere, otherwise we would really have to worry by now.
Since 2010, the mutual fund cash-to-assets ratio has been in the lowest range ever. To some extent this could be explained by technicalities, but one should be careful with rationalizations. It definitely indicates that mutual funds represent a major source of potential selling pressure once the market turns down – click to enlarge.
Lastly, here is a look at one of the main antagonists to stocks, namely US treasury bonds. We find that the exact opposite sentiment currently reigns with respect to t- bonds. The Rydex bond ratio shows that almost 6 times as much money is currently devoted to the fund that is short t-bonds than the fund that is long t-bonds.
What is especially remarkable is that there have been huge inflows into the short fund on a very slight dip in bond prices in early March, and that they have not been reversed in the face of a once again improving bond market (on the contrary, a big chunk of money has flowed into the short fund very recently). Such stubborn bearishness in the face of a better acting market is usually a big red flag.
The Rydex bond ratio – 5.81 times more money is devoted to shorting bonds than to long positions in bonds. Although this ratio has seen much greater extremes in the past, this is still a level that has historically presaged bond market rallies – click to enlarge.
Conclusion:
Caveat emptor. As we always stress, the peak can by definition only occur once, so trying to forecast it is a mug's game. However, it is not a futile endeavor to try to assess the risk-reward situation. Clearly, the current situation is firmly tilted toward risk. That might change again provided a correction produces enough apprehension to quickly and appreciably alter some of the data we have discussed in recent days.
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