Exuberance Marks Start Of 2018

 

Last week, we discussed the record-setting year of the market. Not only did the markets tie the most number of up years for any bull market in history, it also hit records for the longest streak without a 3% correction, lowest volatility, record margin debt and more.

The exuberance that surrounded the markets going into the end of the year, as fund managers ramped up allocations for end of the year reporting, spilled over into the start of 2018 with the S&P hitting new record highs.

Of course, this is just a continuation of the “stair-step” advance that has been ongoing since the Trump election. The difference this time is the extreme push into 3-standard deviation territory above the 50-dma that is concerning.

But it isn’t just the 3-standard deviation above the 50-dma that is concerning, but rather the 3-standard deviation extension above the 50-MONTH moving average as shown below.

That extension, combined with extreme overbought conditions multiple levels, has historically not been met with the most optimistic of outcomes.

Importantly, such extensions have NEVER been resolved by a market that moved sidewaysBut, as I will discuss next, “exuberance” of this type is not uncommon during a market“melt-up” phase.

As I noted last week, we did add some defensive positions to our portfolio allocations while we still retain a fully allocated long-position as well. These defensive “shock absorbers” are simply in place to reduce a volatility shock when, not if, one occurs. 

Exuberance Everywhere

As prices rise, investors become more exuberant.

The longer prices rise, without a correction, the more exuberant and confident investors become.

The longer prices rise, without a correction and with very low price volatility, the more exuberant, confident and complacent investors become.

The problem is that when investors are overly confident, exuberant and complacent, they unwittingly take on excessive amounts of investment risk without realizing the inherent danger. In other words, “investing mistakes” are covered up by steadily rising prices, but will be immediately exposed when prices reverse.

Currently, with markets ratcheting up to new milestone marks on a continually faster pace, it is not surprising that as we turn the page into a New Year, investor sentiment has blown out to the upside.

Individual bullishness, as measured by AAII, is now at the highest levels on record with a massive surge over the last two weeks.

Professional investors, as measured by INVI, is also at a record.

Even our composite fear/greed index which is a combination of AAII, INVI, MarketVane and the VIX is now also registering extreme greed on a rolling 4-week basis.

And, as I showed last week, not only is everyone now “all in,” they are doing so with record leverage.

And, as Dana Lyons noted last week:

“It should be no surprise that this Rydex Bull:Bear asset ratio has risen to an extreme.However, the level to which it has risen in recent days is truly off the charts when compared with historical readings.

As the following chart shows, up until 2014, the ratio generally ranged from about 1:1 to 5:1. In other words, when bullish assets hit 5 times the level of bearish assets, it could reasonably be considered an extreme. Near the market top in 2015, the ratio rose to a then-record (for the period shown, at least) 13.6:1. In the ensuing correction, the ratio dropped back under 2:1 briefly near the market lows in February 2016. Since then, the ratio has steadily climbed back up, reaching close to those 2015 highs on several occasions last year. So, one could certainly have argued that sentiment was back to bullish extremes on those occasions.

However, readings in recent days should leave no doubt that short-term sentiment has gotten a bit frothy. That’s because the ratio has jumped to previously uncharted levels near 20:1.”

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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