Charts created using Omega TradeStation 2000i. Chart data supplied by Dial Data
The chart of the S&P 500 is one everyone who is long the market should be worried about. In terms of bull markets, while the current one may not be the most powerful one following a 50% or more collapse in the market it is one of the longest. This current bull is now over 1,300 trading days old. The other two markets that saw the market fall 50% or more was the bear market of 1929-1932 and 1937-1942.
Not only is the bull long in the tooth in terms of time as I have pointed out before numerous market indicators are flashing danger. Advisor surveys are over 80% bulls a level rarely seen, the put/call ratio is heavily in favour of calls, advance decline lines are diverging sharply with previous highs and the VIX volatility indicator is at levels seen in 2007 as there is almost no fear in the market. The bull market of 2009-2014 is a market that is on steroids.
The market these days does not seem to be concerned about the ongoing crisis in Ukraine. The crisis in Iraq is causing barely a ripple. The S&P 500 hit a record high (once again) following the FOMC meeting where Fed Chairman Janet Yellen slashed the growth forecast for 2014 but said that 2015 and 2016 forecasts were unchanged. While the FOMC hinted at a slightly faster pace of interest rate increases starting in 2015, they suggested that rates should be lower than previously expected. Inflation is running below the Fed’s targets. As expected, the Fed “tapered” another $10 billion.
This past week a story came out through the Financial Times of London (FT) that suggested that the world’s central banks have shifted investments into equities as the low interest rates have hit even their investments. The report to be published is from the Official Monetary and Financial Institutions Forum (OMFIF), a central bank and advisory group. The report identifies some $29.1 trillion of central bank assets are held in market investments. No not all of that is in equities. The bulk of it is in bonds mostly government bonds. Some is held in gold.
An examination of the Federal Reserve’s assets shows that of the $4.3 trillion on the Fed’s balance sheet as of June 11, 2014, $2.4 trillion or 55% is held in US Treasuries. The next largest category is mortgage-backed securities where there are $1.6 trillion or 37%. If the Fed holds equities, it is not being reported.
Not all central banks hold equities in their portfolio. Central banks that were specifically mentioned in the FT article that do hold equities are PBOC, as well as the Swiss and Danish central banks. Outside of PBOC, the equity portfolios were not large. However, OMFIF did note that upwards of $1 trillion of central bank assets were in equities.
What the central banks have done is maintain artificially low interest rates since the financial crisis of 2008 as well as providing trillions in stimulus through quantitative easing (QE). The central banks at the centre of low interest rates and QE are the Fed, the ECB, the BOE and the BOJ. PBOC has provided QE but Chinese interest rates are not what one would call particularly low. Rather than money being funnelled into productive investment, funds instead are speculating chasing the stock market to ever-higher levels. These markets invariably end badly.
Since 2009, the S&P 500 has been forming what appears an ascending wedge triangle. This bearish pattern narrows as the market climbs higher and higher. Since November 2012, the climb has narrowed even further. The S&P 500 appears to be forming a classic ABC type pattern as it rises in the ascending triangle. The S&P 500 appeared to make an ABC rise to a peak in April 2011. That completed the larger A wave. The B wave was the 2011 correction.
Since then it is tricky trying to determine how the market is unfolding. Usually the C wave unfolds in 5 waves. Waves 1 and 2 are clear but it is uncertain at this time whether this current long wave has completed waves 3 and 4. That could still be to come. The ascending triangle breaks down under 1,800. Ultimately, the ascending triangle suggests that the market should go back from where it came from. That is the 2009 low near 666.
Ideally what one wants to see to complete a potential topping pattern is an initial breakdown followed by a rebound that takes the market back to the high or even new highs. This would ideally complete waves 4 and 5. This pattern is similar to what was seen in 2000 and 2007. This type of pattern was also seen at tops in 1946, 1966 and 1972. It doesn’t always happen but it happens sufficiently enough that it would be a strong sign that the final high was approaching.
The stock market is long in the tooth. It has been, for lack of a better description, a market on steroids. Danger signs are flashing. Yet many remain complacent that nothing can go wrong and that the Fed will save the day. Eventually they could be in for a shock.