The levitating stock markets continue to seductively entrance traders, powering to new nominal record highs day after day after day. No one believes a meaningful selloff is even possible anymore, thanks to the vast deluge of central-bank monetary inflation. Sheer euphoria has set in as all perception of risk has vanished. This makes these stock markets extraordinarily dangerous, they are truly at topping extremes.
As of Wednesday, the flagship S&P 500 stock index (SPX) had rallied to new nominal record highs in 11 of the past 13 trading days. It blasted 4.8% higher over this short span. If sustained for an entire year, this blistering rate of ascent would nearly double the stock markets! This latest euphoric surge extended the cyclical stock bull that was born way back in March 2009 to a massive 145.2% gain over 50.2 months.
This move, particularly the one-sided 22.6% melt-up in the last 6 months, has bred unmistakable euphoria. Wall Street vehemently tries to deny this truth, but the definition of euphoria is “a feeling of great happiness or well-being, a feeling of great elation”. Does that not describe the outlook for the stock markets today? There are no bears left, everyone is incredibly bullish and expects no material selloffs.
Normal healthy bull markets climb a literal “wall of worry”, traders are always anxious about some catalyst arising that will spark a sharp selloff. But not today. The markets have run up for so long with nary a hiccup that traders no longer believe significant selloffs are even possible. They expect any selling to be met with immediate buying, effectively backstopped by the Fed’s unprecedented QE3 debt monetization.
All news is being interpreted as bullish today, thanks to the Fed manipulating the markets. If it ramps up QE3, then there will be more freshly conjured money pouring into stocks. If it instead tapers QE3, then the underlying US economy must be improving so cash on the sidelines will return. And of course any poor economic news is seen as forcing the Fed to keep aggressively monetizing debt, again bullish for stocks.
But all markets flow and ebb. Prices rising and falling is the natural order of things. This is because nearly all short-term price action is driven by the perpetually warring emotions of greed and fear. These are mutually exclusive, so prevailing market sentiment swings back and forth between them like a great pendulum. Excessive greed is followed by excessive fear, as the markets always ultimately balance out.
Euphoria, which is built on rampant greed, is the most tell-tale sign of a major topping underway. Traders no longer worry about anything, so their greed drives them to buy every trivial dip. This pushes markets higher and higher regardless of newsflow until everyone interested in buying in anytime soon has already bought in. That leaves only sellers, so the great sentiment pendulum starts swinging back.
I suspect that very peak-euphoria moment is here, when the SPX’s anomalous uptrend suddenly reverses. Contrary to popular belief, this doesn’t require a news catalyst. Once all available near-term buyers are sucked in, sellers assume control by default. Most bull markets top without any crisis or even bad news to spark the initial selling! And that quickly feeds on itself as late buyers rush to cut their losses.
Pretty much every technical or sentimental indicator you want to look at these days confirms the euphoria blinding stock traders. Last week I focused on the excessive valuations, stocks are very expensive so the foolish traders chasing this topping are buying high. This week I’m examining psychology, the extraordinary greed and complacency driven by a one-sided melt-up. And its resulting overboughtness.
This first chart looks at the benchmark S&P 500 in blue and its definitive sentiment gauge, the VIX implied-volatility index, in red. The span encompasses the SPX’s entire mighty cyclical bull market since March 2009
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