Euphoria Sets In

Today’s post will be short and to the point. We have been in a wonderful bull market since March of 2009. We have had a few pull-backs along the way but largely, being long and “checked-out" with regard to allocations and exposures has been rewarded.

MY BEST GUESS: Things get harder from here. Why?

I’ll let the following chart and explanation from famed chartist John Murphy & tell the story.

S&P 500 IS MOST OVERBOUGHT SINCE LATE 1990s... Global stock markets started off the new year with a bang. U.S. stock indexes exploded to record highs for the best start in years. Foreign stock benchmarks did the same, including the FTSE All World Stock Index which also hit a new record. New records were set in North America, Europe, and Asia and in both developed and emerging markets. So what's there not to like? Well, there is one thing. Based on RSI, stocks are very stretched at current levels. That may not be a problem at the moment, but could become one later in the year if some things start to slow down. First let's look at how much stocks are stretched. The black bars in Chart 1 compare monthly bars for the S&P 500 to a 14-month RSI line. Readings over 70 show a major overbought condition. The last two times that happened was in the 2006/2007 period and in 2014 (circles). The earlier condition led to a major downturn in 2008. The later version led to a downside correction in 2015 in excess of 10%. What really jumps out in Chart 1, however, is that the monthly RSI reading of 86 is higher than both of those two prior peaks. In fact, it's now at the highest level since the late 1990s. That puts the S&P 500 at the most overbought level in twenty years. That's not necessarily a bad thing over the short run. But it is a caution sign that things may have gotten a little too good. The 14-week RSI line has now risen to the highest level since 1958. That's sixty years ago. That makes me a little nervous that 2018 may not end as well as it started.

My view:

In the first week of 2018, markets ripped higher and the angle of the price action has changed from steady uptrend to what looks like euphoric FOMO (fear of missing out). If this angle continues, it may not end well for those who don’t understand what they own and why they own it. If there ever was a time to implement some equity strategies that have portfolio flexibility to adapt and shift to a more defensive posture, now is the time. I’m not in the business of making predictions, and the market does not care what I think. However, I have been investing and trading for over 25 years and when the angle of the price ascent changes toward something more vertical, we are typically in the late innings of the advance. It does NOT mean the bull market will be over but it does likely portend a more, lumpy set of returns once the vertical ascent has used its “energy”.

In the stock market, when price go vertical, one of two things generally happen:

  1. 1Price stalls at a high level, chops around for a period of time to work off the massive overbought condition (ideal) or
  2. Price stalls for a bit then gravity pulls it back towards earth for a while.

My crystal ball is no better than anyone else’s but it would be very healthy for
markets to cool off for a bit. The longer we go in “vertical-mode”, the worse the eventual pullback will feel. As the managers of a dynamic equity strategy, we have a significant amount of de-risking tools at our disposal. We are currently dusting off those tools and getting ready to implement them when necessary. Having that ability makes our strategy highly unique in a world filled with “long-only, always invested” equity options.

Now is a wonderful time to assess your equity lineup to see if you have sufficient exposure to flexible equity strategies. If you do not, the burden of de-risking decisions falls on the Advisor or individual investor. My experience tells me most do not have the time, tools, experience, or desire to make market calls. If you prefer to outsource those decisions, consider an allocation to the Rational Dynamic Brands Fund. We would be happy to talk with you about the strategy and how its flexibility can help preserve capital in volatile markets.

Stay tuned.