One Last Breadth: 3 Reasons to Not Trust this MarketAug 08, 2012
Chad Karnes, CMT
The stock market is up for the year, but the reason is not what you would expect. In order to see what is really going on in the markets we need to look beyond the fluff.
A skeptic is defined as someone “not convinced something is true” and typically requires evidence to validate claims made by others. In investing, a contrarian falls into this category. Count me as a big one.
The market (NYSEArca: IVV) is up so far this month, up 2.5% this quarter (NYSEArca: VOO), and up an impressive 11% year to date (NYSEArca: SPY). These market gains have been explained by trusted sources as earnings driven:
- “Earnings Reports Boost Stocks Again on Tuesday” – WSJ Marketwatch
- “Second Half all Comes down to Earnings” - CNBC
But there is something very peculiar about all these earnings announcements this quarter. They haven’t meant squat!
What’s the Real Rally Reason?
In my article on 7/31 and for subscribers in the ETF Profit Strategy Update on 7/25 and 7/29, I discussed the real magic trick being performed by the markets and what really is driving share prices. Hint: it has nothing to do with earnings, but don’t expect any CEO who thinks he is the master of his stock price domain to admit to it.
In that analysis and in the chart below, I point out the Euro (along with other currency pairs) is all that really matters to the stock market right now. If the market wants to rally it must do it on the back of a continued Euro (NYSEArca: FXE) rally. That is what has led the markets higher (and lower) and is what will continue to in the near future.
For a larger view and commentary on the Euro’s importance to the market click here
Reason #2: Complacency
Complacency occurs when expectations of the future are considered non-volatile, lower risk, and with generally positive expectations. Risk during such times is expected to be low. There are many ways to measure complacency, but a few of the favorites are through more subjective sentiment surveys and more objective data like expected market volatility. Sentiment and volatility data are typically used in a contrarian nature.
Currently the general consensus is that sentiment is extremely bearish as the articles below highlight.
- Bearish Investor Sentiment: A Contrarian Buy Signal? – Investing Daily
- Wall Street Sentiment at Record Low – Financial Times
There seems to be an abundance of negative news and commentary, even more than usual. But the fact based data reflects something entirely different, and it is not bullish for the markets. It seems Wall Street may be up to its same ole tricks of misdirection and “do as I say, not as I do” commentary.
If sentiment is at all time lows then why are mutual fund net cash positions still near record all time lows around 4%? At a minimum it means fund managers are still historically bullish (similar to their levels in 2007). For comparison’s sake the same fund managers held closer to 6% cash near the 2009 market lows.
If sentiment is so negative, then why is the VIX (^VIX), which measures the future expected volatility of the markets, near 5 year lows? If fear of the future is so prevalent, volatility expectations and the level of the VIX would be higher. This shows that options sellers are expecting low volatility into the near future and is a sign of bullish "good times ahead" complacency.
These are important data points that show true Wall Street sentiment. ETFs to take advantage of the VIX include the ProShares short term VIX (NYSEArca: VIXY), the ProShares Ultra short term VIX (NYSEArca:UVXY), and the ProShares mid term VIX (NYSEArca: VIXM).
Reason #3: Lack of Breadth
Finally, the Breadth, or range of participation in the market’s moves, is not confirming the recent rally over the past month.
There are less and less stocks making 52 week highs which means the rally is being driven by fewer and fewer companies. There also is less and less volume associated with rising prices shown by the volume advancing/declining ratio. A strong market would have volume following price higher.
The latest ETF Profit Strategy Newsletter provides actionable and data driven trade recommendations based on market technicals, sentiment, breadth, and fundamentals. Even though the market has rallied this year, there are major warnings signs. We see this as a profit opportunity for smart investors.