Following on our earlier observations courtesy of Sentiment Trader that the Nasdaq has hit its the most extreme bullish reading since 2005, and the dumb money confidence is the highest it has been in the same period of time, we now get confirmation from Bespoke that indeed stocks are now merely floating on a see of excess liquidity and nothing else. As Bespoke notes: "The chart below highlights the level at which the S&P 500 has traded relative to its 50-day moving average (DMA) over the last year (measured in standard deviations). As shown in the chart, today’s close puts the S&P 500 into ’extreme overbought’ territory (2+ standard deviations above 50-DMA) and at its most overbought level since November 2009." Expect momentum chasers and dumb money speculators to go apeshit and to buy anything and everything in sight on this latest observation.
And while discussing the most euphoric market seen in years, here are John Hussman just released observations on market conditions:
As of last week, the Market Climate for stocks was characterized by an overvalued, overbought, overbullish, rising-yields syndrome that has historically been hostile for stocks. Clearly, we can't observe what the outcome will be in this particular instance. We can't rule out the possibility that investors will continue to speculate on the hope of ever larger deficits and some further combination of illegal or irresponsible Fed actions. From our standpoint, the return/risk profile of the equity market is the most negative that we ever observe historically, so we are willing to speculate neither on the hope for government wisdom, nor on the hope for government recklessness. Investors who are convinced that monetary and fiscal actions will drive the market ever higher can easily offset our hedges by establishing exposure to the S&P 500 or more speculative alternatives. What I can't do on behalf of those investors is violate our discipline and take a speculative exposure in an environment where the historical evidence indicates an extraordinarily hostile return-to-risk tradeoff.
Our objective remains to significantly outperform our benchmarks over the complete market cycle, with smaller periodic losses. I recognize that it has not been satisfactory simply to lose less than the S&P, but with smaller drawdowns, since the 2007 peak. Still, it would be an understatement to say this has been an unusual cycle. Given the broader set of Market Climates we have defined, I am confident that we will periodically observe more favorable market environments - possibly even in the coming months, without major changes in market valuation - where we will be able to accept risk in the expectation of positive returns. From my perspective, this is emphatically not one of them.
The Strategic Growth Fund remains fully hedged here. Given the hostile Market Climate, and the fact that individual stocks can decline indiscriminately from overvalued, overbought, overbullish, rising-yield peaks, we are also carrying a staggered strike hedge (which moves our put option strikes closer to "at-the-money" levels). Though we expect to close that position at the point where the return/risk profile of the market improves or implied option volatility increases significantly, the last thing we want is to be inadequately hedged in an indiscriminate selloff because we believed our stocks did not have much "beta." Strategic International Equity is also largely hedged, and we continue to establish corresponding hedges as we add new equity positions to the Fund.
Based on historical experience, we are likely to observe a clear acceleration of inflation only after short-term interest rates increase by about 15-20 basis points over a 6-month period, and those pressures will be worse if long-term rates are also rising (at that point, attempts to reduce short rates through Fed easing may have the paradoxical effect of increasing inflation expectations). For now, I continue to believe that the inflation thesis is most likely correct long-term, but that this doesn't necessarily translate into persistent inflation or interest rate pressures over the short or intermediate term. We continue to hold about 1% of assets in precious metals, about 1% in foreign currencies, and about 2% in utility shares.