Market Advance Stalls As Liquidity Begins To Slow

 

As noted last week, there have only been a few points over the previous 25 years where the market has been so overbought, extended, and bullishly optimistic. To wit:

“This is particularly the case given how extreme positioning by both institutions and individual investors has become. With investor cash and bearish positions, at extreme lows, with prices extremely extended, a reversion to the mean is likely and could lean toward to the 10% range.”

Importantly, this was the repeated message over the last few weeks as the Federal Reserve’s “repo” operations continue to fuel the market’s non-stop advance. As Howard Marks once quipped:

“Being right, but early, is the same as being wrong.” 

Clearly, we were early in reducing some of our long-equity exposure in portfolios two weeks ago, but we tend to lean toward the adage; “you never go broke taking profits.” We remain comfortable with our positioning, given the imbalance of risk and reward currently.

Friday, the market had its first real sell-off since early December. As shown in the chart below, the only other times were in early October before the Fed launched its current “Not QE” program. To put this into some context, since 1970, the market has averaged two 1% declines per month or about every 9-trading days. Since October 2, 2018,there have been ZERO days consisting of a 1% decline. Assuming historical averages apply, there should have been nine such events of a 1% decline, or more, by now.

While the media was quick to blame the “coronavirus” in China as the cause for concern, the reality is the markets just needed a reason to sell. As shown in the chart below, the market is so extremely extended, the sell-off barely failed to register. 

There are two critical points to take away from the chart above:

  1. Notice both the overbought/sold indicator (top) and price momentum (bottom) are pegged at market extremes. The previous peak in both indicators was in January 2018.
  2. More importantly, from the 2016 low to the “blow-off” January 2018 high, the market had a 50% Fibonacci retracement. A similar correction from the December 2018 lows to the recent high would correspond with the January 2018 highs.
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