Well, this week, the market not only got off the mat but rallied back to new highs, just barely, as shown below.
While the rally did get the “bulls” motivated, the declining “money flows” (grey histogram chart) suggest the rally is unlikely to stick. With the market back to 2-standard deviations above the 50-dma, conviction weak, and investors extremely bullish, the market remains set up for more consolidation or correction in the week ahead.
The weekly chart confirms the same. Our previous discussions warned that if the daily and weekly “sell signals” align, such often coincides with more “corrective” rather than “consolidative” actions. If the “daily” signal triggers a “buy” next week, such would indicate a limit to the upside, and more consolidation.
I got a few emails this week asking if I still think a 5-10% correction is possible?
The short answer is “yes.” However, it is not a guarantee that such will happen. If you notice in the weekly chart above, the market can consolidate over an extended period and reduce the “sell signal.” A “correction” makes it happen faster. It is also worth noting that corrections can come after “sell signals” are triggered. Thus, they are not always immediately correlated.
As we have laid out repeatedly over the last few weeks, there are several important points concerning technical analysis.
The last point I expand on in our latest 3-minutes video.
There are two other reasons we are cautious of this past week’s rally.
Volume was lacking, and seasonality is still at play.
That view supports our current thesis of remaining slightly underweight equities for now. The market is likely to rally a bit from here for two reasons:
We suggest remaining a little cautious but not overly defensive for now.
One thing about the market is the rather extraordinary amount of “bullish exuberance.” That exuberance often gets visualized, for example, by record margin debt levels.
However, some other “non-mainstream” indicators show the same. For example, a new survey from Natixis shows a clear example of “recency bias” at work.
Of course, with inflation running roughly 5% in the second quarter, such suggests that investors are looking for more than 20% from the stock market by year-end.
But it isn’t just “recency bias.” It is also the “moral hazard” driven by the belief the Fed will continue to support markets indefinitely. The Bespoke “irrational exuberance” indicator subtracts the “Valuation Confidence” from the “One Year Confidence” survey data. This reading has exploded higher recently for both institutional and individual investors.
The key takeaway is that “investors simultaneously believe the market is over-valued but likely to keep climbing.”
Why? Because the “Fed has investor’s backs.”
Of course, we would be remiss not to look at the level of household equity ownership as a percentage of their disposable personal income. The current deviation from the long-term exponential growth trend rivals every previous bubble in history.
Yes, this time could be different. But, unfortunately, it just usually isn’t.