Stocks continue to hover near their highs, but the market starts to looks a bit tired.
We will be entering a new lunar red period this week. The most recent red periods have brought significant gains in most stock markets, but that’s rather unusual. It tends to happen a few times a year and then normal cycles return.
And that’s what I expect right now.
Let’s have a look at the S&P 500 chart (click for larger image):
The S&P 500 reached new all time highs last week, and that has kept my MoM indicator inside the very optimistic +8 zone. As you can see from seven earlier occasions marked in the chart, whenever the MoM pulls back from the +8 zone it is typical to get either a sideways movement for several weeks or a pullback of 5% or more. In February and March-April we got the sideways type, while on the last three occasions we got a deep pullback. The principle of alternation would say we are due for the sideways variant again, but who knows.
Is the market ready for something more than a regular pullback? I don’t think so. Some observers are pointing to high margin debt levels on the NYSE, extreme bullishness in sentiment surveys, or to the low level of the VIX.
But, as I explained last April ( see: Is investors’ money where their mouth is? ), we can easily calculate directly how leveraged investors are based on interactivebrokers.com brokerage metrics. Here is the updated chart (click for larger image):
Leverage at IB customers has actually fallen to its lowest level since October 2012, so despite record highs these investors have turned more cautious rather than more euphoric.
A similar picture is seen in the Investor Movement Index, as published by TD Ameritrade: https://imx.tdameritrade.com/IMX/index.jsp.
That doesn’t rule out a deep correction, but prolonged bear markets typically start from a situation of over-leverage, leading to forced selling, leading to more selling…, in what becomes a negative spiral.
So, I would be more worried when leverage reaches 35% or 40% again.
Good luck,
Danny
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By the way, I just came across this well documented article, which explains why NYSE margin debt levels are nothing to worry about for the moment. Margin debts generally tend to rise and fall together with the market. So when the market is at record highs you will usually find margin debts at record highs as well. That in itself doesn’t tell us where the market is going next.
http://philosophicaleconomics.wordpress.com/2013/10/25/margin-debt/
Danny