As of Friday, the S&P 500 was within 1% of its upper Bollinger band at virtually every horizon, including daily, weekly and monthly bands. The last time the S&P 500 reached a similar extreme was Friday April 29, 2011, when I titled the following Monday's comment Extreme Conditions and Typical Outcomes . I observed when the market has previously been overbought to this extent, coupled with more general features of an "overvalued, overbought, overbullish, rising yields syndrome", the average outcome has been particularly hostile:
"Examining this set of instances, it's clear that overvalued, overbought, overbullish, rising-yields syndromes as extreme as we observe today are even more important for their extended implications than they are for market prospects over say, 3-6 months. Though there is a tendency toward abrupt market plunges, the initial market losses in 1972 and 2007 were recovered over a period of several months before second signal emerged, followed by a major market decline. Despite the variability in short-term outcomes, and even the tendency for the market to advance by several percent after the syndrome emerges, the overall implications are clearly negative on the basis of average return/risk outcomes."
As it happened, April 29, 2011 turned out to mark the exact high of the S&P 500 for the year, and was followed by a steep intermediate market plunge. My impression is that despite the recent run of speculation the market has enjoyed - largely reflecting a reprieve in European debt concerns and what appears to be a drawing-forward of jobs into the first quarter due to unseasonably favorable weather - the extended implications of present market conditions remain decidedly negative.
If you examine the components of the S&P 500 individually, you'll quickly find that the majority of those stocks are also at or through their own upper Bollinger bands. In overvalued, overbought, overbullish, rising-yield conditions, those extensions are often resolved in unison, which is what produces the characteristic "air pocket" where the index can give up weeks or sometimes months of upside progress in a handful of sessions (though we often see a knee-jerk reaction to buy that initial dip before more serious follow-through occurs).
In recent weeks, the market has faced what I've called an "angry army of Aunt Minnies" (see for example Warning: A New Who's Who of Awful Times to Invest and Goat Rodeo), These are indicator syndromes that are generally (and sometimes singularly) followed by steeply negative market outcomes. When I present these in the weekly comments, I'll often give specific thresholds (such as a Shiller PE of 18, 27% bearish sentiment, and so forth) in order to give an idea of where the "border" of a given cluster of data tends to be, but these aren't magic numbers. The objective is to capture a syndrome of conditions that is characteristic of some particular diagnosis, but the outcomes are generally robust to small variations in how they are defined. For example, with as few bears as we have at present, there's little distinction between say, 45% bulls and 44% bulls. As I noted last May:
"We can define an 'overvalued, overbought, overbullish, rising-yields syndrome' a number of ways. The more general the criteria, the better you capture historical instances that preceded abrupt market weakness, but the more you also encounter 'false positives.' Still, as long as the criteria capture the basic syndrome, we find that the average return/risk profile for subsequent market performance is negative, almost regardless of the subset of history you inspect."
The steepest market plunges on record (e.g. those following the 1973-74, 1987, 2000 and 2007 peaks, among others) have generally followed an overvalued speculative blowoff coupled with divergent interest rate pressures. This is why we take the "overvalued, overbought, overbullish, rising yields" syndrome so seriously. Indeed, the outcomes are usually negative on average even without rising yields, but the yield pressures tend to add immediacy. Notably, the emergence of this syndrome has provided accurate warning of oncoming losses both historically, and also as recently as 2010 and 2011.
These syndromes are useful because the combination of several conditions often carries far more information than any of them individually. To ignore syndromes like the ones we've increasingly observed in recent weeks is like having nausea, sudden lower-right abdominal pain - especially following a period of dull pain in the upper abdomen, coupled with an inability to even consider jumping, and shrugging it off as a stomach ache instead of recognizing that, in all likelihood, your appendix has just burst.
Continue reading.
"Examining this set of instances, it's clear that overvalued, overbought, overbullish, rising-yields syndromes as extreme as we observe today are even more important for their extended implications than they are for market prospects over say, 3-6 months. Though there is a tendency toward abrupt market plunges, the initial market losses in 1972 and 2007 were recovered over a period of several months before second signal emerged, followed by a major market decline. Despite the variability in short-term outcomes, and even the tendency for the market to advance by several percent after the syndrome emerges, the overall implications are clearly negative on the basis of average return/risk outcomes."
As it happened, April 29, 2011 turned out to mark the exact high of the S&P 500 for the year, and was followed by a steep intermediate market plunge. My impression is that despite the recent run of speculation the market has enjoyed - largely reflecting a reprieve in European debt concerns and what appears to be a drawing-forward of jobs into the first quarter due to unseasonably favorable weather - the extended implications of present market conditions remain decidedly negative.
If you examine the components of the S&P 500 individually, you'll quickly find that the majority of those stocks are also at or through their own upper Bollinger bands. In overvalued, overbought, overbullish, rising-yield conditions, those extensions are often resolved in unison, which is what produces the characteristic "air pocket" where the index can give up weeks or sometimes months of upside progress in a handful of sessions (though we often see a knee-jerk reaction to buy that initial dip before more serious follow-through occurs).
In recent weeks, the market has faced what I've called an "angry army of Aunt Minnies" (see for example Warning: A New Who's Who of Awful Times to Invest and Goat Rodeo), These are indicator syndromes that are generally (and sometimes singularly) followed by steeply negative market outcomes. When I present these in the weekly comments, I'll often give specific thresholds (such as a Shiller PE of 18, 27% bearish sentiment, and so forth) in order to give an idea of where the "border" of a given cluster of data tends to be, but these aren't magic numbers. The objective is to capture a syndrome of conditions that is characteristic of some particular diagnosis, but the outcomes are generally robust to small variations in how they are defined. For example, with as few bears as we have at present, there's little distinction between say, 45% bulls and 44% bulls. As I noted last May:
"We can define an 'overvalued, overbought, overbullish, rising-yields syndrome' a number of ways. The more general the criteria, the better you capture historical instances that preceded abrupt market weakness, but the more you also encounter 'false positives.' Still, as long as the criteria capture the basic syndrome, we find that the average return/risk profile for subsequent market performance is negative, almost regardless of the subset of history you inspect."
The steepest market plunges on record (e.g. those following the 1973-74, 1987, 2000 and 2007 peaks, among others) have generally followed an overvalued speculative blowoff coupled with divergent interest rate pressures. This is why we take the "overvalued, overbought, overbullish, rising yields" syndrome so seriously. Indeed, the outcomes are usually negative on average even without rising yields, but the yield pressures tend to add immediacy. Notably, the emergence of this syndrome has provided accurate warning of oncoming losses both historically, and also as recently as 2010 and 2011.
These syndromes are useful because the combination of several conditions often carries far more information than any of them individually. To ignore syndromes like the ones we've increasingly observed in recent weeks is like having nausea, sudden lower-right abdominal pain - especially following a period of dull pain in the upper abdomen, coupled with an inability to even consider jumping, and shrugging it off as a stomach ache instead of recognizing that, in all likelihood, your appendix has just burst.
Continue reading.
