A Change in Tune? Decline Unfolding?
It would be impossible for any of my readers to not know my theme of epic greed and euphoria in the financial markets since late last year. Yet, stocks keep forging ahead, almost unabated except for a very brief 4% pullback a few weeks ago. Make no mistake about it, a sentiment landscape like this is not going to end well. To be crystal clear, excessive risk taking is going to be severely punished. Please do not email me with comments that start with “but, but, but”. It will fall on deaf ears.
Now that I have your attention, sentiment is not a great timing tool for a decline. It just says that the market is in the zone for a peak. It’s not as bad as valuation or how expensive the market is, but it isn’t top notch either. With valuation, I remember stocks becoming historically expensive in 1996. There was a 20%, three-month bear market in 1998, but the real high for the major market indices wasn’t until March 2000. Sentiment started to get frothy in early 1999. That built higher and higher to the March 2000 peak.
However, the major difference between the Dotcom Bubble and today is that the market’s foundation is still solid right now. In 2000 the foundation had been crumbling since May 1998. A year ago, there was epic greed and euphoria. But like today, the foundation was fairly stable although not as good as today. That is the main reason I forecast new, all-time highs after stocks plummeted 30%+ to the March 23 bottom.
If stocks fall hard now with the sentiment backdrop coupled with a strong foundation, the recovery should be relatively quick and right back to new highs. I do not believe that will be the case. Rather, I see a series of small declines that weaken the market’s foundation until we finally see a more long-lasting decline that does not immediately and easily recover.
Today, there are several warning signs for a pullback to begin. If it develops, it should be the highest magnitude since the rally began on October 30. That means greater than 4% which isn’t all that troubling given the incredible and enjoyable gains we have seen over the past four months. Should that decline come to fruition, it will also likely be yet another bout of weakness to buy for a fresh run to new highs, albeit with less participation than the past few rallies.
While some caution is certainly warranted now, this should not be the end of the bull market nor should it be the beginning of major decline, at least not yet.