Bull Run Reaches Exhaustion

On Tuesday, we discussed a very important point with respect to the bull run so far.

“Despite the underlying economic and fundamental data, the markets have surged back to extremely overbought, extended, and deviated levels. The chart table below is published weekly for our RIA PRO subscribers (use code PRO30 for a 30-day free trial)”

“You will note that with the exception of bond prices, every market and sector is more than 5% above its 50-day moving average and year-to-date performance is pushing more historic extremes both in price and in extreme overbought conditions. 

Those overbought conditions are more prevalent in the chart below. On virtually every measure, markets are suggesting the fuel for an additional leg higher in assets prices is extremely limited.”

Let me explain why this is important for investors to understand. 

While it is true that there is always a buyer and seller in every transaction it is the “supply and demand” of those buyers and sellers at a particular price point which affects the overall price. 

For example, imagine two rooms of 100 individuals each that want to buy shares of ABC stock. Room “A” has 100 individuals who currently own ABC stock and Room “B” has 100 individuals with cash wanting to buy shares of ABC. The table below shows a very simplistic model of this process.

At $10 a share, there are numerous buyers but very few sellers. The demand for the shares drives the price higher which entices more sellers. As long as the demand for shares outpaces the supply of sellers – the price is pushed higher. However, at some point, the price reaches a level that exhausts the supply of buyers. The next price decline occurs as sellers must begin lowering prices to attract buyers.

So, yes, while there is “always a buyer for every seller” the question is always “at what price" The chart below is a short-term view of the market which illustrates the current backdrop. 

The chart below shows several methods I look at to try and determine if buyers are potentially reaching a point of “exhaustion” which might lead to a price reversal in the short-term. The top of the chart looks at the historical deviation between the price of the market as compared to the 200-dma. The bottom 4-indicators are measures of price movement and participation (The bottom two panels are the number of stocks above the 50 and 200-dma.)

Don’t get too hung up on trying to understand all the nuances of the chart. The important point, from a money management standpoint, is the determination of the potential risk/reward opportunity for allocating capital to the markets at any given time.

As a portfolio manager, clients tend “not to like” having their capital invested in the markets only to almost immediately suffer a principal loss. By using some measures to determine the current risk/reward outcome, the deployment of capital can be more effectively timed.

While the majority of the chart (except for stocks above their 200-dma) is suggesting the market has reached levels where buyers have been more reticent, it is important to understand that just because the indicator has reached an extreme level – the market will not necessarily fall apart immediately. It is a warning sign that suggests further upside in the market is relatively limited compared to the downside risk which currently exists.

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