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Saturday, May 31, 2014

Volatility Disappears Setting The Stage For A Cyclical Market Top

Last week I commented that A New Bubble Has Emerged: Complacency. This topic seemed to resonate throughout the week from some of the top minds in finance who are noticing that there is no volatility in asset classes, anywhere. This type of behavior tends to occur at the cyclical peak of market cycles, shown below with the combined (extremely low) volatility in stocks, currencies and bonds.


In his weekly commentary this morning, John Hussman described market peaks as a process, noting the following regarding the United States S&P 500 index:

"It’s fascinating how investors come to forget that markets move in cycles and not perpetual diagonal lines. A normal, run-of-the mill cyclical bear market wipes out more than half of the preceding bull market advance."


Cyclical market cycles tend to follow a three stage process, which overshoot the long term trend line upward before finally overshooting the long term trend line downward.


During the final stage of a cyclical rally you end up at a point where participants believe that the market cannot fall. Everyone has forgotten the last downturn, and the bears have gone into hibernation.


Who is the big buyer that continues to push the U.S. stock market further into the stratosphere? As Zero Hedge noted this week, it is the companies that make up the S&P 500 which purchased $160 billion of their own stock in the first quarter.

"Unlike traditional investors who at least pretend to try to buy low and sell high, companies, who are simply buying back their own stock to reduce their outstanding stock float, have virtually zero cost considerations. The only perogative is to reduce the amount of shares outstanding and make the S in EPS lower, thus boosting the overall fraction in order to beat estimates for one more quarter."


You'll note that in March 2009, when stocks represented a tremendous discount in comparison to where prices are today, companies wanted nothing to do with making purchases of their own shares. Today they cannot get enough.

It's great to know that stocks are over valued and over loved today by almost any metric in history, but what people really want to know is the day the party is going to end and U.S. stocks will finally return back to earth. Unfortunately, no one can tell you when that will occur. You can either continue to play Russian Roulette with this market and ride the momentum further upward into bubble territory, or you can wait on the sidelines and look foolish with the rest of the rational market participants.

With that said, I believe that when this ridiculous party ends it is going to have a very violent conclusion.

h/t STA Wealth Management