Excessive Optimism, but Money Supply Growth Rate Remains High
We recently remarked on the astonishing levels of optimism currently visible in the stock market. The present phase of excessive optimism has lasted for quite a long time already and has recently begun to once again approach the all time records seen in several indicators at the end of 2013. As we already mentioned on occasion of the last update, there is at least one 'good' reason for traders to be optimistic, and that is the fact that many charts of individual stocks and sectors look bullish (there have been a number of noteworthy break-outs lately, as one would expect).
However, the problem with good-looking charts is that they only look good until they don't anymore, so one has to keep an eye on market sentiment and the money supply. In summary the situation is that the market's underlying technical condition (apart from being overbought) still looks positive, sentiment is at absolute nosebleed levels and giving us a big warning sign, and money supply growth remains strong enough to continue to lend support to the market. The caveat to the latter remark is that y/y money supply growth has halved from its peak, and we cannot know with certainty where the 'bust threshold' will turn out to be this time.
First a chart from sentimentrader, the “smart/dumb money confidence spread” – which measures differences in market exposures of the two classes of traders. The definition essentially regards anti-cyclical market participants as 'smart' and pro-cyclical traders as 'dumb'. This doesn't mean that the former are always right – in fact, they very often aren't right for long stretches of time. However, they will as a rule be right at extremes.
Currently the confidence spread is at -0.42, with 'dumb money confidence' in a continuation of the rally at 71% and 'smart money confidence' at 29% – this is pretty much as bad as it gets – click to enlarge.
Next an update of the chart of various Rydex asset aggregates and ratios we have shown previously:
The mania in all its glory – here we have a series of data that have already eclipsed the manic peaks seen at the end of the tech mania in 2000. The contrast of trader opinions at the 2009 lows to today is striking. When the best time to buy had arrived, there was a broad consensus that the market would go lower. Now there is a record amount of money in Rydex funds betting that the market can only go higher from here. The extent of the capitulation of bears and holders of cash is especially noteworthy – click to enlarge.
Next an update of the “risk appetite index”, which is an amalgam of the risk appetite indexes created by three different banks. The exact definition can be seen here.
A chart of the NAAIM exposure index shows a similar subtle deterioration. It is at an extremely high level, but not as high as it was in late 2013.
This index measures the average net exposure of fund managers participating in the NAAIM survey. Responses can range from '200% long' to '200% short'. The latest value of 88.2 is very high, but represents a subtle deterioration from the 100% and higher all time record net long exposures seen on three occasions last year – click to enlarge.
Next an update of equity and OEX put-call ratios and the VIX. Since the last update, there has been a second notable spike in the one-day OEX p-c ratio (this ratio is considered a 'smart money' indicator, while the equity p-c volume ratio is held to be a contrary indicator).
Equity and OEX one day volume ratios and the VIX. The recent spike in the OEX ratio was probably the highest ever (the highest in 20 years at a minimum). Spikes in the equity p-c ratio to below 0.40 have occurred before, but they are also rare – click to enlarge.
The 10 day moving averages of the above shown put-call volume ratios:
The 10-day moving averages of the p-c ratios have come in a bit, but remain historically at very low, resp. high levels. Note that if a warning signal is legitimate, it usually has a certain lead time (two to four weeks). It is impossible to tell in advance whether it warns merely of a run-of-the-mill correction or of something worse – click to enlarge.
The true broad US money supply TMS-2 has resumed its growth in recent weeks, after a slight dip in previous weeks. Note that we are showing the 'quick version' without memorandum items; these usually add up to another $50-$80 billion (in crisis situations, certain memorandum items can swell to far bigger amounts, but usually they can be safely ignored, resp. one can simply mentally add the approximate amount mentioned above to the total. With the total money supply well over $10 trillion by now, it doesn't make a big difference).
The year-on-year growth rate of the money supply is very important for financial assets. Although it has been roughly cut in half from the peak, it remains historically quite high at nearly 8%. As can be seen, the crisis was precipitated by a mere slowdown in monetary inflation. This phenomenon can be observed prior to every financial market crisis of the modern era. Funny enough, the bureaucrats responsible for the sequential bubbles and busts seem not to be aware of this (at least we have never heard any of them mention it) – click to enlarge.
There is still plenty of inflationary support for the market, but with sentiment at nose-bleed levels and some measures continuing to send warning signs, some kind of setback is probably brewing. Note also that 'tapering' will eventually lead to a further slowdown in money supply growth, although there is the caveat that the commercial banks have recently upped the pace of fiduciary media creation (i.e., the creation of money from thin air by dint of inflationary lending). Even though money supply continues to be supportive – which actually opens up the possibility of a blow-off move continuing for a while – one must also keep in mind that margin debt is extremely high and cash reserves at mutual funds extremely low. A sharp market break has therefore the potential to snowball. Risk remains extremely high.
Charts by: Sentimentrader, StockCharts, St. Louis Federal Reserve Research
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