The Central Bank Experiment & Asset Bubble (Update)
Last week the markets began a corrective move and started showing signs of weakening. The following graphs will update you on the previous week. We will update you this week as the markets react to earnings season.
S&P was making new highs through the July 4th holiday weekend in the face of a revised annual GDP growth rate of -2.9% This market is still extremely overbought and expensive relative to PE and other growth metrics. We still feel a larger corrective move is coming in July. We believe we are hedged perfectly. Last week the markets topped out and started a corrective move downward however, the bulls are fighting and have not given up yet. The longer they fight, the deeper the correction will be when they finally give up.
NASDAQ is at a 14 year high. Performance for the year is annualized at 90% . This market continues to be extremely overbought and we feel a corrective move is coming in July. We believe we are hedged perfectly here as well. Last week the NASDAQ topped out and showed signs of a corrective move downward however, the bulls are fighting and have not given up yet. This market is holding up the strongest but is extremely overvalued in our opinion. Again, the longer they fight, the deeper the correction will be when they finally give up.
Russell Small Cap Index
The Russell Small Cap Index tends to lead the markets. It is the riskiest of all of the Indexes. We caught the entire move short and have now reversed our position and gone long (short-term) to counter our other short hedge. We still believe there is downside but we are waiting for the other markets to follow through before we resume our short position.
Volatility Index (VIX)
These extremely low levels of volatility have only been seen just prior to market corrections. Complacency is at an all time high. Last week volatility began to increase. Option premiums have begun to expand. We are more convinced that a correction is coming and volatility should spike.
Current Trading Strategy
Extremely low volatility and overbought conditions have returned to the financial markets. As such, we have begun to step up the level of trading (positioning) and risk (position size) proportionate to our confidence that our trading models will respond properly. We have a large trade (short position) on the market and are monitoring it full time. We are currently net short with several positions. The markets are moving in both directions, however they exhibit an unrealistic upward bias and we feel confident in our position as the markets normalize. With the markets fluctuating hourly, we have been trading around the core net short position and repositioning for a reversal that is long overdue.
The market’s overbought condition and investor complacency are significant as we enter the middle of the summer months especially after the frequently forecasted seasonal event “sell-in-May-and-go-away” did not come to fruition. We feel the correction has been delayed and that the summer months could still see a corrective period through late August when equities typically find a bottom, consolidate and prepare for a move higher in the fall months. With all of the historical research we follow combined with the headwinds that the markets are still facing (Fed tapering, reduced growth forecasts and potential geopolitical events), we have repositioned our portfolios to protect and prepare for a corrective move.
When the seasonal period runs its course and/or the markets tell us that they want to move higher based on our research, we will remove the hedge and begin the process of getting back into the markets and get fully invested. Until then we remain diligent in our research and will continually monitor the markets and report back as data become available.