Déjà vu, all over again!

[su_youtube_advanced url=”https://youtu.be/BfxCITbi5EA” rel=”no”]On April 21, 2011, I sent the following commentary to our clients at ValueTrend regarding the state of the markets:[/su_youtube_advanced]

S&P neartermOn April 21, 2011, I sent the following commentary to our clients at ValueTrend regarding the state of the markets:

“We think that September or October might bring a sizable correction, so the current period and coming 3-4 months will likely be sideways. Our strategy: Reduce equity at or near S&P 1340 to hold some cash.  The S&P 500 seems to be consolidating between 1280 on the low side and 1340 on the high side. While markets could overshoot to the up or downside within this range, our conservative nature feels the risk is growing as we near to the top of this range.”

We raised about 40% cash within our equity model that spring. The result was that after the market fell some 22%, the ValueTrend equity portfolio fell by less than a third of that – ending up with a relatively benign 7% drawdown.

Below is the chart that I was looking at when I made that assessment. On my client commentary, I also referenced high margin levels by retail investors, and low money market levels held by retail investors.  Are these conditions similar to those in 2011? Let’s take a look.

S&P 2011

Recently, I have been suggesting that the time is ripe for a 10-20% correction on North American markets. Market breadth and the fact that we haven’t had a correction over 10% since 2011 suggest such an event long overdue. Adding to this condition is the fact that margin levels are at all-time historic highs—along with their reciprocal: all-time low cash availability of NTSE members. In other words, there seems to be so much margin borrowing lately that the member brokerage firms are running low on cash!

Further to the point of excessive optimism, www.sentimentrader.com notes:

“Mom-and-pop investors have drawn their money market balances down to the lowest level since 1998, while large institutional investors are nearly holding their largest amount of cash in four years. Prior to the last two bear markets, there was a similar divergence between the two, but much larger than we’re seeing now. The behavior of the largest investors will be something to watch in the weeks and months ahead. If they start adding aggressively to their money market balances, it will be a warning sign that trouble is likely brewing.”

The S&P chart below shows some similarity to that of the spring of 2011. If the S&P500 continues to follow a similar pattern, it may indeed follow through with further downside, a rally, and then a bigger correction later in the summer. In 2011’s case, the lion’s share of the correction occurred after an upswing in July following June’s weakness. Certainly, optimism by retail investors – as witnessed by margin debt and low money market mutual fund holdings – suggests the conditions may be ripe for a similar correction to occur.

S&P nearterm

11 Comments

  • At times like this when the signs of a correction in the broad markets seem so obvious, would that stop you from buying a stock which has just broken out from a long basing pattern and the breakout is supported by many of the other indicators.

    Reply
    • Yes Bob–we tend to hold off when a correction is likely–even when we see breakouts. Currently we are 42% cash in our model

      Reply
  • Interesting sentiment analysis. It seems the market is waiting for the Feb to move rates higher. Then people will have an alternative to stocks and put more into something with a decent interest rate. Until that happens, it seems everyone is hesitant to sell because there is nowhere else to go.

    Reply
    • Yes, my view is that we are in a larger picture bull market, with a near termed correction likely. The rise in rates, even when it starts, will be slow and not too aggressive–and that wont likely crush stocks. So beyond an apparent near termed correction (much needed), I really don’t see much to stop this train over the next few years.
      Looks like June is following the 2011 path of a correction, given news from Greece so far. If things continue like 2011, we may see further weakness through June, then a July rally, then another turndown in August – September. We’ll see.

      Reply
  • Thanks for the commentary!

    The only thing that bothers me is that everyone…and I do mean everyone…is calling for a correction. It’s hard to believe that the market is going to make it that easy. No doubt there will be some serious head fakes along the way?

    Reply
    • Oh for sure deshy
      I expect it will be a choppy ride at first, and possibly even a rally in July like in 2011 before a real selloff occurs.
      Or–no correction –remember, this is a game of probabilities, not crystal ball gazing. I’m looking at the odds of a selloff as greater due to technical factors and sentiment factors–but no one really knows!

      Reply
  • Would it be a good idea to buy some gold etf to hedge the upcoming correction?

    Reply
    • Nick–I am considering a gold trade, but seasonals are usually best to buy in July–so I am waiting until that point before making a decision

      Reply
  • Hi Keith,
    I am trying to understand the sentiment of the market. The comment you noted from Sentiment Trader seems to be different from this comment also from Sentiment Trader. I greatly appreciate your comments and analysis.

    “The latest release of positioning in futures contracts brought
    another surprise. Large “smart money” commercial hedgers in
    the major index futures showed a huge $10 billion swing in their
    net exposure. They are now the most exposed to stocks in more
    than three years. While it’s not quite this simple (see yesterday’s report for an
    example of why not), these two indicators set up a stark
    divergence between the big money, who is the most optimistic
    in a year, and mom and pop, who is the most pessimistic in a
    year.”

    Reply
    • Yes, “Smart money” seems to be coming back to the plate–but the mom and pops, via equity vs. MMF ratios and NYSE margin levels are off-the-charts bullish. Please watch the video on the blog to see those charts.

      Reply
  • Keith, individual stocks are already in correction mode.

    WSP.TO, BEP-UN.TO, most rails, many REITS, utilities like NPI, for example.

    -Bob

    Reply

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