In case you missed it, Friday marked the five-year anniversary of the intraday low of the Credit Crisis bear market.
However, the closing low was set on March 9, 2009 at S&P 500 676.53. Thus, through Friday's close, the current bull market has gained 177.6 percent. Not bad for a period where the bears were quite sure the sky was actually going to fall -- on several different occasions.
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Sure, things were downright ugly five years ago. At the close of March 9, 2009, the S&P 500 found itself down 25 percent on the year. This after losing 38.5 percent the year prior. Yep, things were looking pretty grim at that time. As such, people were giving up on the stock market as an investment class in droves.
But then, it happened. With just about everyone in the game (yours truly included) convinced that the global banking system was on the verge of collapse, JPMorgan's (NYSE: JPM) Jamie Dimon stepped up to the press microphones and said something to the effect of "You guys know we're making money, right?"
It's A Bull Market...
Now fast-forward five years. Today, the rolling five-year track records of the same growth funds that had been slaughtered first in 2000-02, and then again in 2008-09 (lest we forget, both bears produced losses from high to low of more than 50 percent), look great.
The public has gotten over its fear of stock market losses. Stocks like Facebook (NASDAQ:FB), Google (NASDAQ:GOOG), Tesla (NASDAQ:TSLA), SuneEdison (NYSE:SUNE) and Yelp (NYSE:YELP) look great -- and sectors such as biotech (NYSE:XBI) are soaring. Heck, even "Mr. Softie", aka Microsoft (NASDAQ:MSFT), is looking investable again.
Thanks in no small part to Ben Bernanke and his merry band of central bankers, the stock market is back. Real estate is definitely on the way back. And bonds...well, that's a story for another day. The point is that giving up on the U.S. stock market, especially when things look bleak, is usually a bad idea.
...But Trees Don't Grow To The Sky
However, it is important to remember (although honestly, it is hard to imagine that anyone has forgotten) the stock market is not a one-way street. Well, not for long, anyway. Every once in a while the bears awaken from hibernation and go on a rampage.
Remember also that the average bull market lasts about two and a half years -- and is then interrupted by a bear market. Historically, bear markets last about nine months and produces losses of about 31 percent. Therefore, attempting to sidestep such unpleasantness would appear to be a worthwhile endeavor.
The trick is to be able to identify when the environment has changed. You see, when the environment changes and the bears come to call, that "buy the dip" strategy needs to morph into a "buy when there is blood in the streets" strategy.
Anyone Can Buy Stocks, It's Knowing When To Sell That Counts
Of course, being able to buy when everyone is losing their heads means you had to have sold at some point. And this timing, dear readers, is the focus of this current missive.
Last November we highlighted a long-term sentiment indicator that has warned of some pretty significant bear markets in its time. These sell signals don't occur very often -- but they have usually been accurate, albeit a bit early at times.
Such is the case when playing the sentiment game. And with most of our sentiment indicators continuing to wave yellow flags right now, the key takeaway is the next meaningful decline may be closer than all those perma-bulls would care to believe.
Let's look at another long-term indicator that has a pretty good record of calling bear markets, and one that just recently flashed a sell signal.
The Margin Debt Indicator
Here's the way this indicator works. We are looking at total margin debt. But we are only looking for periods when margin debt is first excessive and then -- and this is the key part -- reverses.
Frankly, looking at the total amount of margin debt on a monthly basis isn't helpful. Due to the changes in the marketplace and the ever-increasing accessibility of margin debt, there is little surprise that the chart of total margin debt since 1970 slopes upward from the lower left to the upper right of the chart.
Now We're Talkin'
Again, looking at total margin debt isn't really helpful at all. However, if one looks at the rate of change of margin debt, now we're talking.
Here's the indicator: Take a 15-month rate of change of total margin debt. When the 15-mo ROC rises above 48 percent, history shows this to be an "excessive" rate of change. In short, this means that things are heating up in the stock market.
But if we've learned anything about sentiment indicators, it is that excessive speculation is not, in and of itself, a signal to sell. No, it is when speculation reaches an extreme and then reverses that really matters.
What To Watch For
So when the 15-month rate of change of total margin debt first rises above and then falls back below 48 percent, a sell signal is given.
Since 1970 there have been a total of 11 sell signals. In our estimation, seven have been "killer" signals -- such as the sell signals in 1973, 1976, 1987 (yes, before the crash), 1998, 2000 -- and then there were double sell signals seen in 2008. Nice.
However, there were also a couple of clunker signals given over the years. For example, one would have needed a buy-stop in 1984 and 1993, as the market simply charged higher after the signals were given.
Because of the "bad" sell signals, the overall stats for this indicator aren't that impressive. Three months after a sell, the S&P was down -0.8 percent on average, versus the average return of +3.1 percent for all three-month periods since 1970.
Six months after a sell, the S&P was up one percent on average versus 6.5 percent for all six-month periods. Twelve months after a sell, the S&P was up 3.0 percent versus 13.9 percent. And 18 months after a sell, the S&P has lost -1.7 percent on average versus a gain of 21.6 percent for all eighteen-month periods.
The key takeaway here is, this particular sell signal tends to be either VERY right...or just plain wrong. However, if you know this going in, using a buy-stop at something like five percent above the prior high could help make this indicator very useful.
Remember Not To Fight The Tape
This is the second signal we've seen since November from indicators that are designed to tell us when things are getting frothy on a long-term basis. Does this mean it is time to head for the hills?
In a word, no. Remember, bull markets can go farther and last longer than almost anyone can imagine. Therefore, unless you like making big bets (and being wrong for long periods of time), it is a good idea to avoid "fighting the tape."
Perhaps the best way to know for sure that things are starting to break down is to keep an eye on the long-term trends. At this stage of the game, we will argue a meaningful break below 1740 on the S&P 500 would be a clear warning that the bears may be starting to mount a return.
So perhaps the best way to play right now is to continue to ride the bull train -- but recognize that indicators such as our long-term sentiment and margin debt ROC are suggesting that the market may be starting to "set up" for the bears to awaken from a good, long nap.
Put another way, feel free to keep dancing at the bull party, but please keep an eye on the nearest door.
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