Extreme Optimism Confirms A Short-Term Top In The Markets

Let’s start this post with a great quote from the legendary investor Warren Buffet:

“Be fearful when others are greedy, be greedy when others are fearful”.

Since the US Presidential elections, the SPX has risen from 2139.6 on November 8th, 2016 to 2271.7 on December 13th , 2016 which constitutes a rise of 6.17% within just over a month.

The rise has been fueled by the expectations of tax cuts and enormous fiscal spending intended to boost inflation. In turn, the Fed is most likely to raise rates at a quicker pace, which has sent the US Dollar Index to 13-year highs.

With this in the background, almost everyone who invests have all gone long in hopes that the markets will continue to rally. After all, there are many who have forecasted lofty targets of 3000 and above on the SPX for this year. This extreme optimism has led to the markets being skewed on the long side.

Evidence Of This Extreme Optimism

Another proof of point of this extreme confidence is shown in the double digit +10 score in the Gallup’s US Economic Confidence Index, which is not only at the highest level since the index started in 2008. However, it is also the first time that the index has hit double digits, which were in the negative only a few months ago.

Similarly, the Rydex Fund data proves that the mutual fund traders have abandoned the short side of the fund and are getting aggressively long.

Currently, the bearish fund assets are at their lowest level.  For every $1 invested in the bearish fund, the bullish fund has attracted $20 worth of investments.  

The last time that this happened was at the end of 2015, after which the markets went through a sharp correction period during the first two months of 2016. Rydex funds are a fantastic gauge on what the average market participant is doing and feeling – Contrarian Indicator.

Considering the timing and the cyclical nature of the markets, I believe that a similar pattern will play out sometime during the second half of 2017.

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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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