What a week. Reddit & retail traders caught the world’s attention, stocks fell, hedge funds blew up, etc. Here’s what matters underneath an ocean of noise.

Weakening breadth

Breadth was incredibly strong for several months but is now weakening. The % of Russell 2000 stocks above their 10 day moving average has fallen below 35% for the first time in a long time.

Historically, such a weakening in breadth led to more short term losses for the stock market. The Russell 2000, one of the strongest indices since October, may be about to take a meaningful breather:

Meanwhile, large speculator positioning towards the Russell has turned negative for the first time in half a year. The only other time speculator positioning was positive for so long ended with the Q4 2018 stock market correction. This is a sample size of n=1, so take it with a grain of salt.

Insiders selling & taking advantage of speculation

Corporate insiders continue to sell their stocks while very few buy stocks. There was a surge in insider selling in stocks that exploded higher this week on retail buying. In other words, insiders are counting themselves lucky and selling as much as they can to the retail buyers.

1. PETS: CEO, CFO, and 2 Directors sold millions in stock
2. Interactive Brokers: CEO and CFO dumped millions in stock (before the uproar)
3. Medallia: CEO sold $14.7 million in stock
4. Blackberry: CFO and CMO sold almost their entire stake in Blackberry

Frothy sentiment

Sentiment has just started to back off from excessive optimism levels, but still has a ways to go before sentiment can be a bullish factor for stocks.

As I noted on Wednesday, the NASDAQ’s Daily Sentiment Index is elevated:

Historically, this was a minor short term bearish sign for the NASDAQ over the next 2 weeks:

The S&P 500’s Daily Sentiment Index is also elevated:

This is a short term bearish factor for the S&P over the next month:

Surge in supply for speculation

As I noted on Wednesday, private market investors are using this surge in speculation to unload risk (moving risky assets from their hands to those of public market investors). The value of unprofitable IPO issuance broke its previous record in 2000.

The above chart does not account for the fact that the total stock market’s capitalization has increased from 2000-present. Dividing the above figure by market cap, the value of unprofitable companies’ IPO issuance as a % of market cap is still more than 50% below its peak in 2000.

Nevertheless, this is not a long term bullish sign for U.S. stocks. Today is not “just like 2009”.

Risk of a black swan

The CBOE Skew Index (risk of a black swan) remains elevated, and its 30 day average can only be matched by 1 other period in market history: July-August 2018. This is a minor bearish sign to watch out for in the coming weeks:

Dollar’s weak rally

The U.S. Dollar and stock market have been inversely correlated since March 2020. The U.S. Dollar’s recent weak bounce has coincided with a stock market pullback. In the meantime, USD sentiment is still extremely pessimistic:

Sentiment is not that useful in commodities and currencies, 2 markets which can exhibit very strong trends. Once trends in these markets get going, they can really get going, pushing aside any sentiment extremes.

Historically, extremely low U.S. Dollar sentiment was not a bullish signal for the dollar. Perhaps stocks will continue to pullback while the Dollar bounces weakly, and once stocks rally again the Dollar will fall to new lows.

Improving economy

The U.S. and global economy will improve in 2021. The Conference Board Leading Economic Index’s year-over-year % change has climbed back to -1.7%:

Much of the stock market’s post-recession gains had already occurred by the time the Conference Board LEI bounced back. The S&P’s 9 months forward returns were weaker than random:

Conclusion: market outlook

Here’s how I approach markets based on 3 different strategies & time frames.

1. Long term investors should be highly defensive right now. This speculative bull market may last another 6 months or even 9 months, but in 2 years time, long term investors will be glad they did not buy today.
2. Medium term contrarian traders should go neither long nor short. Wait. Risk:reward doesn’t favor long positions right now, while shorting into a speculative rally can end in disaster.
3. The market’s short term uptrend remains intact for now. This may change in the coming days with breadth weakening around the world.