Amber Light

Although this month’s blog post sounds more like a beer preference, we would like it to be a bit of a cautionary tale.  As I was discussing the current market environment with a colleague on Twitter, he mentioned that recent market action reminded him of a note he sent to his clients in the mid-1980s entitled, Amber Light.  In a former life, he was the CEO of Prudential Equity Group, and while nothing had happened to force any portfolio changes for his clients, he felt there was enough anecdotal evidence to suggest market sentiment was getting closer to reaching stretched levels (he also happened to be right).

In our opinion, the stock market has been flashing a yellow light for several weeks now, and while ANY market indicators must be confirmed with price (better to be reactive than predictive), we now feel some of these indicators have turned more of an “amber” color (between yellow and red).

1. The first indicator is the Citigroup Panic/Euphoria Model.  If you are an avid business journal reader, you may recognize this chart that comes out in Barron’s each week.  The first time the market had reached the euphoria level was in January of this year and was certainly a cautionary tale, but as you can see we have been squarely in the euphoric region for over two months.  There are no holy grail indicators in this business, but rather each one is the piece of the larger sentiment puzzle, which we attempt to decipher during each market cycle. 

2. The second piece of the puzzle is the top-heavy nature of today’s market.  There is always clear leadership in the stock market and the larger companies will always have an outsized effect on market returns, but if the broader market refuses to participate in the rally, this concentrated growth tends to roll over.  The top 5 stocks in the S&P 500 make up more than 20% of the index for the first time in 40 years. (Chart: Goldman Sachs Global Investment Research)

3. According to Ryan Detrick of LPL, there has never been a year in which the S&P 500 has been down 30% at any point in the year and finished the year positive.  Will 2020 be the first?  While there is a first time for everything (not unlike the entire year so far), we hesitate when our minds wander toward “this time is different”.

4. The Nasdaq’s 20-day moving average has gone up 75 days in a row.  This is the 6th longest streak ever and each of the five previous streaks led to pullback in the NASDAQ and S&P 500 over the next month. (Per Jason Goepfert at SentimenTrader).

5. Below is the 10-day average of the Put/Call Ratio.  This chart shows how many people are betting on the market moving lower relative to those betting that it will continue going higher.  The two previous lows on this chart were in late January 2020 as well as right before the 1869 point down day in the Dow Jones, less than two months ago.  (H/T to Helene Meisler of realmoney.com for the chart).

What does this mean?

For long-term investors?  Not much.  Until the primary trend for the major averages turns down, each pullback should be considered a buying opportunity, and for truly long-term investors, the market going lower in the short-term may actually be a net positive.

For those investors waiting to deploy cash that has been on the sidelines for one reason or another?  I believe that you will get your chance in the coming days/weeks.

For short-term traders?  Now is not the time to jump in with both feet, and those of you with individual trading accounts outside of your holdings with us, I would keep a very close eye on the markets for a tonal change.

The purpose of this note is not to alarm anyone.  There is a lot of data that suggests in 12-24 months we could be 20%-25% higher than where we are right now.  We just feel that the market is stretched and is due for a much needed pullback.  The pullback could be sharp and swift and just don’t want anyone to be unprepared.

As always, Brad and I hope everyone is staying healthy, and we are here if you need anything.

– Adam