Technically Speaking: Signs Of Exuberance Warn Of Correction

During the past couple of weeks, I have discussed the rising levels of exuberance in the markets. Importantly, that exuberance combined with surging margin debt levels warns of an impending correction.

I recently discussed why this is not a “new bull market,” which changes the dynamic of the understanding of “risk” in markets.

Following actual “bear markets,” investor sentiment is crushed, valuations revert toward their long-term means, and price trends are negative. Notably, few investors are willing to “buy” assets in the market. However, “corrections” do not accomplish any of those outcomes.

While the mainstream definition of a “bear market” is a 20% decline, such has little relevance to what constitutes a “bear market.” As noted in “March Was Only A Correction,” there is a significant difference.

“The distinction is essential.

  • ‘Corrections’ generally occur over short time frames, do not break the prevailing trend in prices, and are quickly resolved by markets reversing to new highs.
  • ‘Bear Markets’ tend to be long-term affairs where prices grind sideways or lower over several months as valuations are reverted.

Using monthly closing data, the “correction” in March was unusually swift but did not break the long-term bullish trend. Such suggests the bull market that began in 2009 is still intact as long as the monthly trend line holds.

signs exuberance correction, Technically Speaking: Signs Of Exuberance Warn Of Correction

Several other factors confirm March was just a correction.

Investors Are All In

As noted, following an actual “bear market,” investors are very slow to return to the market. Following the “Dot.com” crash, it took several years before investors returned their allocation levels to “fully allocated” levels. The same occurred following the “Financial Crisis.” 

However, following the March decline, investors quickly allocated back into equities, which coincides with corrections rather than bear markets.

signs exuberance correction, Technically Speaking: Signs Of Exuberance Warn Of Correction

Further, as we discussed in “Sign, Sign, Everywhere A Sign,” investors are now “all in” in terms of portfolio risk. As noted by SentimenTrader on Saturday:

“We didn’t think traders could get any more speculative than they were at the end of August. We were wrong. For the first time, small trader call buying (adjusted for equivalent shares) exceeded 9% of total NYSE volume last week.”

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Comments

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Edward Simon 1 month ago Member's comment

A correction is likely coming a few weeks into the Biden administration either due to a stimulus showdown in Congress or an escalation of domestic tensions in the U.S..

Kurt Benson 1 month ago Member's comment

Agreed.