January 31st, 2013
Everyone right now is trying to figure out how vulnerable the market is to a serious correction as it approaches its previous all-time highs. For example, CNN recently posted a piece entitled “Bull market winding down. Don’t panic” in which they overlaid onto the 2009-2012 S&P 500 the template of the market’s traditional psychological life cycle. [FYI, I've used that template myself in many earlier postings. For example, two years ago in Two Views of the Same Image, some had voiced fears that investors were "euphoric" and that meant that the market was approaching a peak followed by a significant downturn.]
In the recent CNN article, Laszlo Birinyi Associates suggested that the bull market “likely entered its final stage last summer. So far, the S&P 500 has climbed almost 8% during this period of ‘exuberance’.” Birinyi, says this stage of the market’s life cycle is when “fireworks” happen….. when all the people who have been reluctant and hesitant to invest in the stock market start realizing this isn’t the New York City subway system. There’s not going to be another train coming so they better get on board.”
The CNN article concludes that some of the best gains are to be had in the market’s final stages as everyone begins to pile onto stocks. This year, that run could be even more impressive as the fixed income bull market ends and investors sell those investments in favor of equities.
When I look at the S&P Index over the same period, I don’t see some rather arbitrary demarcations of changes in market psychology. I see another interesting pattern of market behavior (click on image to enlarge):
At the risk of being labelled an Elliottician, that is a practitioner of Fibonacci patterns and Elliott Wave Theory, I see that this bull market looks like a stair-step affair with each successive leg of the bull run lasting only 50-70% of the previous leg and the % change of each leg being only 50-80% of the immediately preceding one. The intervening steps down were less regular; excluding the 2011 correction that was amplified by the European debt crisis, each correction leg lasted approximately 60 calendar days and each (again, other than 2011) was 50-70% of the prior one.
Call it a stair-step or ever more tightly wound spring …. no matter what the analogy, the trend is unsustainable. In the next correction down leg down could be the last of the series. Each of the four previous corrections were between 50-70% of the immediately previous upleg. If it holds true again, a correction beginning soon could carry the market down to approximately 1410-1415, another pivot at the bottom boundary trendline.
Looking at the psychological terms in the Birinyi chart above, I can’t come to grips with calling today’s market psychology as “exuberant”. The reason the market saw an unusually large cash inflow in January was because they’ve been nearly non-existent since 2007. Even though we aren’t hearing much today about the inadequacy of job creation, consumer demand is still weak and businesses still hoard their cash fearing a weak economic future. Actually, the market rose 225% since March 2009 not because of a growing economy but only because of how far it had fallen from 2007 to March 2009.
Before there can be market “exuberance” there needs to be exuberance concerning the world economy, a condition that may be near but clearly hasn’t arrived yet. After the coming correction, psychology surrounding the economy might have improved sufficiently to allow the market to quickly maneuver around the tip of that coiled-spring and make a run at and finally, after 14 years, cross above the all-time highs.