Posted by Danny on November 4, 2013
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.