Turning Long-term Bearish
Bernie
Schaeffer
Schaeffer’s Investment Research Inc.
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If you've been following my market commentaries in recent months, it's no secret that I've had major concerns about the depth and breadth of the potential risks and the high degree to which Wall Street strategists, money managers, and economists have been willing to ignore those risks.
My recent Option Advisor newsletter commentaries have addressed longer-term technical concerns for the stock market, specifically the potential for major resistance around the 1,150 area on the S&P 500 Index (SPX). I viewed this area as critical in part because it is the site of the 80-month moving average, a trendline that acted as support on a monthly closing basis in September, 2001. This area is also the site of the 2002 high as well as the 50 percent retracement from the March, 2000 peak to the October, 2002 low. Despite numerous assaults on 1150, this level held steadfastly as resistance.
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I had maintained a "neutral" long-term posture on the market, as I viewed the huge shorting activity in such ETFs as the Nasdaq-100 Trust (QQQ), S&P Depositary Receipts (SPY), and DIAMONDS Trust (DIA) as a source of potential demand and as tinder for short-covering rallies. I also respected the fact that money managers were enjoying a huge influx of cash from mutual fund investors that was being put to work to support the market.
Ironically, it was these huge mutual-fund inflows that rivaled those of early 2000 that was also a serious concern, as major market peaks usually occur when investors feel most comfortable and ignore the dangers that are lurking.
Now I'm taking firmer action on my cautious views by switching (as of May 10) from a long-term neutral posture to a long-term bearish posture. Why now?
One of the major sources of potential demand has been muted; specifically enormous short interest in the ETFs discussed above. In the latest reporting period, for example, SPY short interest plunged by 28 percent, while DIA and QQQ encountered drops of 24 percent apiece.
Despite the combination of short covering and the huge cash inflows into equity mutual funds, the market could not take out key resistance levels. In fact, the price action has further deteriorated.
It has become clearer that 1150 on the SPX is indeed a major long-term resistance area.
It is obvious that interest rates are headed higher. But what's also obvious is Wall Street's incredibly complacent reaction to this reality, as in "rising rates are OK because it means the economy is growing and corporate pricing power and earnings will benefit from this growth.” So falling interest rates were bullish for the market and now rising rates are also bullish? Who says perma-bullish Wall Street has learned a lesson from the bubble? As Ben Graham once said, "Wall Street learns nothing and forgets everything."
First-quarter earnings have been terrific. In fact, they are beating estimates by record amounts. But stocks are not reacting positively to this "bullish news," even with the huge dollars being thrown at the market so far this year.
This is a market that has had many reasons to stage an impressive rally over the last few months. The shorts have been squeezed, money managers have harvested huge amounts of fresh cash, and earnings have been nothing short of outstanding. But all these potentially powerful forces have failed to drive stock prices higher. So who is selling? All indications are that major distribution of stock has been taking place from sophisticated investors to unsophisticated investors. And such distribution inevitably occurs at significant market tops.
Investing accounts should continue to be heavily weighted in cash. Longer-term index put options can serve as protection against a major market decline. And I continue to recommend that a major portion of your capital at risk be devoted to energy, energy services, and gold-mining stocks.
Bernie Schaeffer will be available for questions until Sunday, May 23. Don’t miss this chance to ask your questions using the below form.
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