[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]
“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.
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.