Markets love to climb a wall of worry. Kim detonates a nuke or fires an ICBM and stocks fall for a day before heading back to record highs. Two monster hurricanes damage the US economy and stocks fall for a day and then immediately roar back to record highs. Trump fails to pass any stimulative legislation and the market shrugs it off on its way to yet more new high valuations. Yet despite a stellar 10 month 17% stock market rally without even a 4% correction, the wall of worry remains close with negative sentiment few weeks ago reaching the most worrisome levels since the 2016 election.
Our recent inflection point we projected in a recent newsletter for an August 21st bottom has led to a very sharp 4 week rally to date. The next turn could occur within a day of September 20th “if” prices remain near record highs.
Short term, stocks face reduced sideline buying power now that option traders have become strong call buyers betting on even higher prices. Typically when the 10 day Put to Call ratio moves from over 70 to under 60, stock market gains become more labored and the risk of small corrections is elevated. Despite some resistance to an immediate run to much higher prices, its important to note that option trader sentiment on August 21st reached the most oversold levels of pessimism in almost 16 months.
Another supportive factor for stocks have been the low risk reflected in Junk Bonds. When Junk Bonds bottomed in early 2016 they have led or confirmed every run higher in stocks. There have been almost no short term negative divergences, but over the past week a minor under performance by junk bonds has yet to confirm the new highs this week in some stock indices. This can easily be erased should Junk Bond prices move higher near term or stocks move lower. Stay tuned!
Like Junk Bond yields we can also track the risk ratio of sub investment grade bond yields with treasuries. When this risk spread widens, as it did during the Oil market recession in 2015, stock prices fall. Since the energy recession ended in February 2016 the risk spreads have narrowed to levels (3.81) just above 10 year lows (3.35). Until spreads rise above 4.16 it may be hard for stocks to fall more than 3 to 5% which keeps our investment exposure at 95%.
Stock prices are elevated, margin debt keeps hitting new records and this Bull market at 102 months is closing in on the record duration of 113 months in the 1990’s. However, as we often say, Bull markets have no expiration dates and typically end with obvious signs of an overheating economy and credit tightening. Facts remain that household debt service burdens are among the easiest in history, banks are actually loosening credit, risk ratios are mild, credit is cheap and unfilled jobs are near record levels of pent up demand. There are signs of faster growth in our future, but almost no indication of economic and credit cycle peaks that are the hallmark of impending recessions and equity Bear markets.