08/15/2016 - Market Observation Notice
Although from one perspective, we could see the S&P 500 reach 2,500 (closed at 2,190 today, so that would be 14% above current levels), before we see a major correction or bear market in US Stocks, we feel incumbent to point out some market facts that have us substantially concerned.
First, trend following funds in Dow E-Mini Futures have reached a new record net long position. This means they are running out of dry powder to drive that market further. Once they exhaust their buying capacity, prices generally stall unless something triggers a bout of short covering in the Commercial community, which is not likely. Commercial participants, generally believed to be the "smart money", particularly at extremes in those contracts are at record net short positions. Therefore, any price weakness could trigger a series of stop loss selling episodes that could feed on itself. We see similar positioning in two of the four futures indices that we track. So not all indices are in as risky position. If all of them were similarly situated, we would advise being mostly in cash (US Treasury Money Market Account), and even potentially net short, by holding more in inverse stock funds than stock funds generally. We aren't to that point now. So, we don't advocate a net short position at this time, but do believe one should hold substantial cash and be meaningfully hedged, but certainly not over-hedged at this point.
See the first chart on the attached sheet to see market participant positioning in Dow E-mini futures. The blue line represents net fund positions and the red line indicates net commercial positions.
Next, according to a few valuation methods, US Stock Prices are from 63% to 108% over-valued compared to the geometric mean of each method. See the second chart on the attached page. You will note that this overvaluation substantially exceeds the October 2007 market peak. Though not nearly by as much as the pie-in-the-sky valuations we saw before the dot.com bubble popped in March of 2000, the overvaluation metrics are at alarming levels nonetheless. We are very close to the levels last reached in 1929, before the market crash of that year.
Next, we see significant divergence between price trend and Relative Trend Strength. We call this a bearish non-confirmation and it is generally a warning sign of a trend change from up to down. Stock indexes are shown at the top of the 3rd chart and corresponding relative trend strength at the bottom of said 3rd chart.
Next, when our evaluations metrics applied in the 2nd chart are reduced to standard deviations, the average of all of the metrics today stands at 2 standard deviations. These were only exceeded in 1929 and 1999.
Finally, pursuant to the so-called "Buffet-Indicator" of Prices over Gross Domestic Product, shown in the last chart, we are narrowly below the Q1 2015 market peak, and those and current levels have only been exceeded at the Q1 2000 market peak.
While none of these are timing tools, the indicators illustrate what we view as undeniable substantial market risk. So based upon a risk/reward perspective, we think it is advisable to once again, add to cash (US. Treasury Money Market) by reducing your stock positions with an emphasis on US stock positions and consider hedging open stock positions with inverse stock positions. At some point, you'll be glad you did. To be sure, because we haven't reached extreme trader positions in all US stock markets and because it appears that emerging market stocks have started a solid up trend, we still advocate a net long positions, with some emerging market exposure. If and when US stock markets head South, this will likely present a good buying opportunity to increase emerging market stock positions.
We have the same view on precious metals. At some point, due to extreme net long fund positions and extreme net short gold and silver futures positions, gold and silver are likely to correct at least, if not resume the bear market. Our target is $915 per ounce gold, but if gold were to retrace to the average retracement level of prior bull markets, 78%, we cold see $600 gold before a real bull market in precious metals kicks in.
There is similar market participant positions in long dated US Treasuries Bond Futures. Hedge funds set an ALL-TIME RECORD NET LONG total in 30-year T-Bills. Accordingly, consider hedging any remaining portion of your bond positions with the inverse long dated treasury fund.
Emerging Market bonds have been on a tear. Kudos to those of you that followed our suggestion to consider increasing exposure there. However that market and emerging market stocks are starting to get over-heated, so take some gains now (but don't abandoned the space if you have a long holding horizon) and get ready to buy the correction that is sure to come.
DISCLAIMER:
This is a Market Alert and Potential Investment Opportunity notice. It does NOT constitute investment advice, which can only be provided in the context of full knowledge of an individual client's financial position and goals. Hence, this notice, and all such notices (whether or not this disclaimer is provided) should be considered by the participant in connection with advice from their own investment advisors.
Our obligation to the plan is to maintain sufficient investment options so that participants can manage risk and capitalize on opportunities. This free notice service is beyond our contractual duties to the plan and is provided as a supplemental service which participants are free to accept or reject.
Thank you for your attention to this notice. We greatly appreciate your trust and confidence in us and wish you and all of the participants the best in achieving your retirement objectives.
