Goldilocks and the Three Bears

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Sometimes keeping the forest from the trees is the hardest thing to do.

Think about this dilemma when it comes to the markets.

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For the past two years investors, traders, and everyone in between have been conditioned to buy the dips as they have been rewarded time and again for doing so.  But as the Chief Market Strategist at ETFguide it is my job to separate the forest from the trees.  It is my job to recognize when seemingly constant themes are not as they seem.

The Short Term Trees versus the Long Term Forest

To me, the trees in the analogy are the shorter term extremes and the forest is the longer term big picture.

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The trees are the seemingly non-stop rallies and market momentum that have sucked in advisors, newsletter writers, leveraged speculators, and analysts into thinking stock markets only go up, resulting in them being fully vested in equities today.  For those that don’t think this to be the case I suggest you check out the Investors Intelligence bull versus bear survey and see that the percentage of advisors that are bearish sits at a 27 year low.  Or check out the amount of margin debt at the NYSE today compared to other times it has peaked.

These facts we have discussed in some of our recent newsletters as well as the one released this weekend.  The trees are causing extreme bullishness, but the forest suggests extreme caution.

The trees also are exemplified by the near record amount of money losing IPOs coupled with record setting debt issuances and 100% IPO returns that signal just how much financial engineering, not fundamentals, are driving the markets right now.

My article back in late 2013 warned of this when I discussed “Twitter and the 100% club“.  All discussed in that article, Twitter (NYSE:TWTR) is now down over 40% from its peak in price last December after missing earnings yet again, The Container Store (NYSE:TCS) is down over 50%, and Whole Foods (NASDAQGS:WFM) is down over 40% after it was warned in that research piece that a significant top in its price was forming when it was trading for over $60.

The trees are also how the largest IPO in history (NYSE:BABA) can be funded.

These are all short term phenomena and they tend to happen time and time again near one end of the extreme of the markets’ cycles.

These kinds of events do not happen at market bottoms, quite the contrary.  They are products of excessive optimism that self fulfill from a rising market, until simply that optimism breaks.

Is Your Porridge Tasting Just Right?

I have labeled the following chart “Goldilocks and the Three Bears”, which I think is fitting considering goldilocks was the term pounded down our throats by Wall Street near the 2007 housing driven market top, and just before the worst financial crisis since the Great Depression.

Larry Kudlow, economist, in September 2006 was the primary user of the term as he explained back then, “We are enjoying a goldilocks economy, not too hot and not too cold”.  While he was trying to convince us how great the economy and the stock market was, housing stocks (NYSEARCA:XHB) had already seen their all time peak in price a year earlier, in 2005, still not exceeded today.

And, Wall Street is now back to its old tricks it seems as the New York Trifecta of newspapers ran headlines recently suggesting once again the economy is back in “goldilocks” territory (just search the recent news headlines for goldilocks).  All three of these articles were interestingly timed within one month of each other, near the recent stock market top (NYSEARCA:SH).

I did another search to see if I could round out the Goldilocks market top trifecta and low and behold, a widely cited publication by Robert Gordon at Northwestern was written in 1998 about just how perfect the temperature of the late 1990s economy was, just as that robust economy was coming to an end.

Remember in the late 90’s when it was “Not too hot, not too cold, but just right”.  History doesn’t always repeat, but it certainly rhymes.

The breakdown in the trendline shown on the chart above is the forest.  That forest is warning us that history may be again rhyming after a similar 5+ year rally, goldilocks claims, and epic speculation.

We should get a few more clues down the road if we are on our way to another major decline.  There’s not enough evidence yet to suggest so, but many of the warning signs certainly are there.  Now we just continue to watch the technical picture for confirmation of the breakdown, as the technicals, as they always do, remain the last remaining holdout.

The ETF Profit Strategy Newsletter and Technical Forecast help our subscribers stay ahead of the markets and find profit opportunities across asset classes.  Right now sentiment, fundamentals, and the global macro environment all suggest a market much nearer a top than a bottom.  The lone holdout is just the technicals.