We shared a note on Sunday from Morgan Stanley asking "What To Do About All This Optimism" the bank said that "in November, December and now January, no question or concern has come up more often than 'everyone is optimistic.'" On Monday, screaming most shorted stock rallies and wild speculation is clear evidence the market bubble continues to inflate.
After a dramatic rebound from the coronavirus crash last March, investors are overly optimistic, and perhaps new observations from BofA on Monday can finally answer Morgan Stanley's question of what investors should do with all this optimism, that is, "take some profits or other defensive measures."
BofA's technical analyst Stephen Suttmeier published a note on Monday titled "Correction risk increases moving into February," point out that as January comes to an end, seasonality risks in February may suggest it's now time to "take some profits, or other defensive measures, as several market indices achieve upside counts projected by the 2020 Election breakouts."
Suttmeier said S&P 500 (SPX) probed the upside target 3,830-3,885 from the bullish triangle constructed ahead of the US presidential election, the Russell 2000 (RTY) has hit its first upside target, the NASDAQ 100 (NDX) tests the 13,500-13,630 target.
BofA's market technician has a yearly bullish view of SPX 4,000+. Still, in the short-term, he envisions a tactical downside risk developing from complacent put/calls and a lack of bullish confirmation of the rally into early 2021 from the percentage of SPX stocks above 10-day and 50-day moving averages, cumulative net up the volume on the SPX, Chicago Fed Financial Conditions and the investment-grade corporate bond ETF (LQD).
Suttmeier adds a weekly Demark upside exhaustion signal was triggered on SPX ahead of the bearish February seasonality. With the risks of a correction mounting next month, he said any downside would be considered a "buyable correction within a larger bullish trend for equities."
In chart one, Suttmeier said SPX has "achieved upside targets" of 3,830 to 3,885 targets. He said, "should upside stall at or near this projected resistance heading into February, which shows weaker seasonality going back to 1928, the key supports are 3,750, 3,663 - 3,620 and the prior highs from September and October 2020 at 3,588 - 3,550."
In chart two, BofA's market technician said RTY has achieved "its first upside count at 2,160."
"The last three US Presidential Elections in 2012, 2016, and 2020 saw big bullish breakouts for the Russell 2000. The post - 2020 Election breakout from a 2- year+ base achieved the first upside count on the RTY at 2,160 last week, and we are not ruling out some backing and filling from this projected resistance," he said. If key supports at 2,026 to 1,927 and 1,742 to 1,700 are held, the analyst said 2,440 could be the next upside target.
In chart three, NDX probes the upside target of 13,500 to 13,630. If the index stalls from here, he said, "the immediate support is near 12,530, but the triangle breakout stays intact above support at 12,268 - 12,090 down to 11,800, which is backed up by rising 13 and 26 - week MAs."
In chart five and six, both the 5-day and 25-day CBOE total put/call ratios are at contrarian bearish overbought levels. The analyst said, "We view this as a risk," something that could interrupt the equity rally next month.
In chart seven, Suttmeier shows the percentage of SPX stocks above 10-day MAs is declining. This is a negative tactical divergence heading into the weaker month of February.
In chart eight, the percentage of SPX stocks above 50-day MA begins to breakdown.
In chart nine, cumulative net up volume on the SPX does not confirm the rally.
In chart eleven, lower highs on LQD is a significant concern that can interrupt SPX rallies.
Suttmeier takes SPX monthly seasonal data back to 1928 and outlines how February is a risky month for investors, especially given all the optimism and speculation in the epic bubbles created by no other than the Federal Reserve.
A weekly Demark 13 upside exhaustion signal was recently triggered on SPX. Move evidence suggesting a correction in the index could occur next month.
Sentiment indicators for SPX are approaching euphoric levelss from 2018, 2015, and 2011.
US Corporate High Yield Average OAS has yet to blowout again, back to pre-coronavirus levels.
With BofA suggesting a correction could be approaching in the coming weeks, Morgan Stanley points out investors are overly bullish as Goldman Sach's chief economist outlined days ago in a lengthy note titled "What Could Go Wrong" with the 2021 rebound, other downside risks remain "including uncertainty about how consumers will respond to lingering risks and how new virus mutations will affect virus spread and vaccine efficacy." Some more details on these three risks:
- The first downside risk, according to Goldman, is that consumers remain more cautious than expected, even as mass vaccination and warmer weather greatly reduce virus spread and the risk of infection. While this could restrain the consumption boom, consumer surveys and the resiliency of the consumer thus far suggest such downside is likely limited.
- The second, "more concerning downside risk" is that virus mutations significantly increase the bar for herd immunity, either because they are far more infectious or because they decrease the efficacy of existing vaccines. This would likely delay the consumption boom by pushing back the date when the US reaches herd immunity and virus risks diminish substantially.
- The third, most severe downside risk is the evolution of a vaccine-resistant virus strain that would require a new vaccine and another round of vaccination. Virus-sensitive spending would likely retrench while a new vaccine is developed,and although a new vaccine could be approved in less than five months, the consumption boom would likely be delayed until 2022
With downside risk mounting, RIA Chief Investment Strategist Lance Roberts explained Monday morning why he started selling stocks and raised cash for clients ahead of what he believes could be a market correction.
The biggest take away is that investors are too optimistic heading into a traditionally bearish month.