Originally posted on October 21, 2013
Personally, I think even attempting to call a top on this character of an equity market is an exercise in the self-infliction of pain for now. It has been a long time since I've seen this type of speculation, but it's been never since I've seen this type of monetary largesse. Moreover, when was the last time both the Fed and politicians have meaningfully attempted to "shape" societal perceptions, let alone hoped for economic outcomes, via manipulation of the financial markets? We know capital is "concentrating" right now, and the repository is US and large global equities. The Fed has been 100% successful in forcing capital into equities and real estate, exactly as their years ago game plan detailed. Likewise, with the tapering genie now out of the bottle, we are watching a rescission of global capital that originally spread out across planet Earth as QE went to ever greater heights since 2009. The outgoing tide is now coming in. These two forces, domestic investment concentration in one asset class and an incoming tide of liquidity from broader global risk assets (think emerging markets, commodities and the metals) characterizes the moment. And for now, liquidity and the weight and movement of global capital trump strict fundamentals. Nothing new, we've been here before.
But a funny thing happened on the way to new equity highs recently, for the first time in many a moon we've begun to see more than a few noticeable technical divergences. Remember, technical analysis is a suggestion, not a hard and fast mandate. It suggests to us what might be, as opposed to definitively speaking to what will. Technical signals, especially in this character of a market, can change meaningfully and fast in both directions. A lot of tried and true historical "systems" have simply broken down for now. After all, technical analysis is tough enough in a free market environment, let alone the type of one in which we now find ourselves. As always, adaptability is essential for survival.
I promise, the last thing I'm trying to do in this discussion is call a top. This is merely an attempt to provide perspective. I've seen many a market that was a "no lose" environment...until the losses started. I've seen markets where complacency reigned for an extended period...until it didn't. You know the routine. So rather than pontificate about where equities are headed next, primarily because I have no idea (and neither does anyone else), I thought I'd simply let a number of charts do the talking. Again, perspective, not predictions.
One very apparent divergence we're seeing right now is the NYSE advance/decline line relative to the S&P itself. The cumulative AD line has been in a range since mid-May, while equities have journeyed to recent new high territory.
Believe me, I'm fully aware of the fact that the NYSE is polluted with a ton of fixed income proxies or surrogates. Makes a lot of sense that the cumulative AD line has been in a trading range since mid-May as this was when the rumblings regarding tapering began, certainly impacting fixed income and surrogates.
But I think it's also important to remember that in the period leading up to the 2007 equity market peak, it was credit that was first in trouble, then came equities peaking followed by commodities. Interestingly before the final equity market peak in 2007 (a lower high on the cumulative AD line), the cumulative NYE AD line when into a good bit of a trading range between mid-May and late July, diverging from equities themselves. Again, just perspective.
Next up is a quick look at the Summation index. Briefly, the Summation index is really a running total of the McClellen Oscillator (measuring net advances). Simply, it's another perspective on breadth. At least over the past year or so, whenever the Summation Index has dipped below the 600 mark, we've either been in or about to start at least a 5% equity correction. Not this time...so far. This is the longest period of time we've stayed below that demarcation line over the past year and yet still not even a minimal 5% correction.
Just for fun, what was the setup in '07?
Continuing tangentially with this theme of breadth, let's have a look at the S&P bullish percentage index. English translation? The percentage of stocks in the S&P on point and figure buy signals. For now, it's a clear declining tops formation again dating back to that fabled month of May when Fed minions started yacking about tapering.
The 2007 version of BPSPX life?
Not an exact match by any means, but one has to admit it's rhythmically similar to what we see today. All of the three sets of charts above deal primarily with breadth. They deal with participation. The Summation Index and the Bullish Percentage indicator are telling us that individual equity participation at each new recent high in the S&P since May has diminished in sequential fashion. Participation has narrowed. Often a classic precursor fingerprint preceding meaningful market peaks, but unfortunately in the elusive ways of the markets there is zero indication of timing when or where that peak may occur, if ever. How's that for definitive?
Three more quick charts that also deal with the issue of level of participation among equity index constituents. Pretty simple stuff, below is a look at the percentage of S&P stocks above their 50 day and 200 day moving averages in the following two charts.
I'll spare dragging you through the 2007 comparatives where we likewise saw similar divergences.
As one might expect, the message of the two charts is consistent - lower levels of total participation at each iteration equity peak since May.
One last look at broad market participation from yet another lens of the level of equities achieving new highs. Below you will see a massive spike in NYSE weekly new highs early this year. Not unexpectedly, it occurred alongside the breakout of the S&P to new all-time highs. Yet since that time as the nominal S&P has floated higher, the number of new weekly highs has plunged to levels last seen when the S&P was near 1400. I've marked in the chart a number of other periods over the last ten years where we've likewise experienced a quick drop in the number new weekly highs. These were associated with 5-10% corrections (admittedly it was a good bit worse moving into early 2008. This time around, no 5-10% correction, at least not yet.
Enough. So there you have it, a number of diverging market points of view that have developed in multi-part harmony over the last six months. Rather than making guesses about what is to happen to equities ahead, I think the key message here for asset managers is one of respect. Until these divergences are cleared up, if you will, we need to respect the dictate of risk management. Every technical divergence is not a message to run for the hills. But when a multiplicity of divergences appear, it's a loud message to heighten risk management strategies until there is clear resolution of these divergence in one direction or another.