Good Morning. I'm sure you've heard all the bear arguments by now. Stocks simply can't go any higher because the major indices are overbought... because the rally is extended... because the rate of change is too high... because the Fed is artificially inflating prices with their QE efforts... and/or because market sentiment has become too optimistic. However, it is important to understand a couple things. First and foremost, let's remember that this is Ms. Market's game and she can do any damn thing she wants, any time she wants. And second, we need to recognize that all indicators don't work in all market environments.
If you are going to try to manage the risk/reward relationship of this bucking bronco called the stock market, I believe it is vital to understand that you need different tools for different jobs. For example, the same pedal-to-the-metal, aggressive approach that worked well in the 90's was a disaster during the "Tech Bubble" bear of 2000-2002 and the "Credit Crisis" bear that occurred from mid-2007 through early-2009. And by the same token, using the capital preservation techniques that saved your bacon during the bear markets has meant missing out (or worse) on the tremendous opportunities for profit that have presented themselves during the 2003-2007 and 2009-?? bull market cycles.
Granted, I am using big-picture examples here. But the same concept holds true on an intermediate-term basis as well. While the bears continue to grouse about the overbought condition or how long it has been since the market has seen a correction, they fail to realize that when stocks are on a roll, an overbought condition is a sign of strength and not a reason to try and call the top of a move.
The exact same idea can be applied to the sentiment indicators. As I have attempted to explain on several occasions, a high level of optimism in the sentiment surveys is not a reason to head for the hills when the bulls are running the show. As I detailed in Looking for a Market Top Indicator back in March, investors should worry when sentiment indicators (in this case I'm using a 10-week average of the number of bulls divided by the number of bulls plus bears from the Investors Intelligence survey) hit extreme levels and then reverse lower. However, too many of our furry friends in the bear camp continue to believe that high optimism readings are a sell signal. While this is true in bear markets, again, you need to use a different tool (or use the same tool differently) in bull market environments.
Another example of this concept is the idea that oscillators or mean-reversion oriented indicators do not work very well when the market is in a "trending" mode. And the bottom line here is that the market is most definitely "trending" at the current time. Therefore, selling every time the upper band on your stochastic indicator is breached is a recipe for disaster in a market that is moving higher. No, if you are going to use these types of indicators, understand that you're going to need to see extreme readings before any type of reversal usually occurs.
You may have seen this already, but the comparisons between this year's stock market performance and that of 1995 have been making the rounds lately and it helps explain my point this morning. Ned Davis Research is always on the lookout for historical trends that are either repeating or at the very least, rhyming with the current market. NDR says that the "nearest neighbor" to what we're seeing in the stock market so far 2013 can be seen in the years 1954, 1964, and 1995.
Bespoke also agrees that 1995 may present a good roadmap for the rest of the year. Check out their chart below showing 2013 (in red) versus 1995.
Obviously, it is silly to expect the stock market to perfectly mirror something it has done in the past. But I have been around long enough to know that sometimes the past can indeed be an indication of what might come next. So, if you are one of those stubborn bears that think the next severe decline is just around the corner, you may wind up being sorely disappointed.
But then again, maybe I'm the one that's wrong. Maybe the thesis that I've been touting this year (No New Crisis Means No Severe Correction) will be wrong. Maybe this IS the top of the current run. Maybe the Fed will start to "taper" sooner rather than later. Maybe Japan will call a timeout on their QE program. And maybe Europe will start to implode again.
And what if I AM wrong, you ask? Well, that's why we have models, indicators, and systems that are able to adapt to changing environments. Because in the long run, knowing which tool to use, and when to use them is the key to getting the job done right.
Turning to this morning...
Although the volatility in Japan continues (the Nikkei was down -5.15% overnight), the rest of the major developed markets do not seem to be having difficulty this morning. Despite a relatively light news flow and rising rates in Italy, European markets are higher and the U.S. futures have moved from red to green.
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