Do you consider yourself a market bull, or a market bear? Many of us will dodge this question by answering “I’m neutral.” The direction of the market is ultimately determined by the immutable laws of supply and demand. If the bullish camp is more confident and aggressive, they will overwhelm the bears and drive prices higher. The reverse is also true.
This might be a good time to review the arguments coming from each of the two camps.
The Bullish Case
- The S&P 500 has risen in 8 of the last 9 months.
- The only losing month – March – was a 0.4% hiccup.
- Confidence is rising for consumers, investors, and businesses.
- Volatility is at historically low levels.
- Earnings have rebounded, with a 12% increase in the 2nd quarter.
- Profit margins are fat.
- Unemployment is at a very healthy 4.3%
- Trump is still the President.
The Bearish Case
- The stock market looks tired.
- The pace of gains is slowing.
- Valuations are stretched.
- Market internals are starting to weaken.
- The Fed is preparing to withdraw liquidity.
- They have already started raising rates.
- Wages are not rising fast enough to stimulate spending.
- Geopolitical risks are high.
- Trump is still the President.
Since March 9, 2009, the bullish case has dominated. My view is that it’s usually a mistake to bet on the reversal of a long-established trend until there are tangible signs that a reversal is likely. I try to let the numbers tell me when to play defense, rather than letting my emotions drive my investment decisions.
The Bull Market is still alive, but getting tired
To get a sense of the diminishing strength of this bull market as it ages, I arbitrarily subdivided the full eight years (2009-present) into three segments, or Acts.
The 1st act was from 2009-2012. It was by far the strongest phase of the bull. This is typical for major bull markets.
The 2nd act was from 2012-2015. You can clearly see the slowing of the rate of increase on the chart.
The 3rd act, which we’re in now, is weaker still.
Sharp-eyed readers may say, “Hold on. The 3rd act is shorter than the other two. That’s an unfair comparison.” To which I say, o.k. Let’s extend the 3rd act by eight months, which will even out the monthly counts to 36 for each act.
The only fair way to do this is to extrapolate. Not optimal, but better than nothing. Here is my calculation, which I’m sure will be checked for accuracy by the same sharp-eyed readers.
1. 19% gain over 28 months = 0.67% gain per month, on average.
2. 0.67% gain extrapolated over the next 8 months = 5.4%.
3. 19% plus 5.4% = 24.4%. Still less than half of the gain in the 2nd act.
A closer look
So that’s the view of a tiring bull market from 10,000 feet. Now let’s zoom in to get a close-up view, starting from the election in November and ending on August 4.
This chart tells me that even though the market has rallied since the election, the pace of the rally has slowed significantly. The dotted red line shows that the average weekly gain has dropped from 0.5% to 0.2% since the election.
The current health of the market
The conditions of the 4 traffic lights this month are mixed, but positive on balance. Market fundamentals and technicals are flashing green. That’s why I remain nearly fully invested in risk assets. Risk is flashing yellow, primarily due to stretched valuations and geopolitics. Valuations are the sole red light.
Why is the market still setting new record highs?
In my view, there are two factors above all that are enabling the market to grind higher. The first is investor optimism (aka sentiment), and the second is the technical support (aka market internals).
Many of the other indicators we follow have stalled, and a few may have started to roll over. I’ll start with the percentage of stocks that are currently trading above their 200-day moving average. The chart shows that this indicator peaked nine days ago and looks like it may roll over.
The NYSE advance-decline line peaked 13 days ago, and it also looks like it may be rolling over.
The NYSE new highs minus new lows index also peaked 13 days ago.
Given the recent weakness in these indicators, how long can the Technical indicator of market health remain green? It’s impossible to know, but this is why I’m suggesting caution and vigilance along with a fully invested (or nearly fully invested) allocation.
Up days vs. Down days
There are 21 trading days each month. In a typical month, there are 12 up days and 9 down days. The current count is 12 up days, indicating a normal reading for this indicator.
While valuations are stretched, investors apparently believe that the strong earnings rebound will continue, and thereby cause valuations to become more reasonable. They still believe that the promised benefits of Trump’s pro-growth agenda will become reality. This bull market is likely to continue, until valuations become too stretched or the market internals roll over, investors start to lose confidence about tax reform, infrastructure spending, the return of high-paying factory jobs, etc.