Research & Advice


Slightly Bullish, But Alert

Much of my work is based on different sentiment models because I like to go against the crowd at extremes.  One of the most popular sentiment measurement tools is the VIX.  And while it has improved a little bit just recently (i.e. gotten more bullish), over the last month we have seen levels that were clearly indicating excessive complacency (borderline optimism) by U.S. stock investors.  And since the best markets tend to climb that proverbial “wall of worry”, I am paying close attention the indicators and am prepared to change my strategy if need be.  But currently I am giving the bulls the benefit of the doubt and intend to stay in line with the tape (i.e. direction of the market).

Now the astute reader might ask themselves that if the VIX is suggesting that the crowd is optimistic right now, and if Allen is remaining optimistic, then isn’t he just part of the crowd he tries avoid?  Don’t worry, that irony is not lost on me.  And it concerns me.  But the VIX is just one tool.  And also lending to the stickiness of my slightly bullish strategy is that it is when optimism is an extreme that we need to be very careful.  While complacency is perhaps at an extreme, optimism is “merely” very high – certainly not high enough yet for me to be confident in making a contrary call. 

The problem with market corrections/crashes is that they do not always hit extreme levels of optimism first.  So, in addition to numerous other indicators, I will also be watching the tape.  Currently every leading U.S. equity market index is trading above or at their respective 200-day moving averages.  Should a good number of them begin breaking down then that would argue for correction-risks and warrant some attention and/or action.

In addition to complacency drifting towards optimism, I do have a lot of macroeconomic concerns (an inverted yield curve, slowing liquidity growth, a weakening housing market, decelerating earnings growth, etc.).   And I’m more so worried (and maybe even more so perplexed) at the duration of this cyclical bull market rally.  An old bull can still be a strong one, if it is in good shape.  However, although this one is still in good shape, historically speaking it is hard to imagine that we go another year without a real correction since a cyclical bear (think 20% over 2-4 months) typically occurs once every four years. 

The Dow Jones Industrial Average (DJIA) has gone 132 days without a 2% correction (on a closing basis).  That’s the longest span since 1958.  Additionally, since 1926, this is currently the longest stretch for the DJIA to go without a 9.6% correction – 1,408 days since March 11, 2003 (200 days longer than the second longest stretch). 

We are simply overdue for a decline in stock prices.  And because it has been a long time since investors have experienced some downside volatility, they may feel like it is the end of the world – but it will really just be a very normal situation (statistically speaking there are three-and-a-half 5-percent corrections from intermediate market tops every calendar year). So for now (even with a correction likely) I will give the bulls the benefit of the doubt.