Market Pulse – Uptrend Is Still Intact

$SPY and $QQQ continue to make new highs on almost daily basis as capital has rotated into the energy sector and Oil & gas names have become frequent visitors on the all-time high list.

The trend is still intact.The dips in market averages are short-lived and shallow.Equities still outperform fixed income by a healthy margin; consumer discretionary overshadow staples, signifying improving perceptions of economic growth. Will those expectations materialize is another question, but at the time being the sentiment is optimistic and a good market mood can go a long way.

Under the relatively calm surface, there has been a natural decrease in risk taking. Small caps have slipped against large caps, but the uptrend of the ratio ($IWM vs $SPY) hasn’t been compromised in any way. On the same note, emerging markets have also been lagging as of late.

There has been a slight dip in inflation expectations as ironically the latest positive economic reports have diminished the probability of further quantitative easing. (on a side note, given the monstrous size of banks’ excess reserves, there is absolutely no need of further Fed’s engagement). The trend of the ratio $XLB vs $XLU is still intact and this should be the case in an improving economy.

Another quick way to take the market pulse is by comparing the number of liquid stocks dropping 5% or more in a day vs the number stocks gaining 5% or more in a day. Today, we had 41 pluses and 35 minuses – normal consolidation within a low-correlation market of stocks.

The averages seem extended to the naked eye, but there are no objectively measurable signs of impending serious price correction at this point.

There Are 3 Stages In a Typical Bull Market

“Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.” – Schopenhauer

Typical market uptrends go through three main sentiment stages:

1) “What bull market? The fall is right around the corner”

Most of the signs of an uptrend are already here – money is leaving defensive names in order to chase higher yield, breadth is improving, correlation and volatility decline substantially. Despite of that, many people don’t believe the rally and prefer to short “overbought” names, only to get squeezed by the tidal wave of monstrous accumulation.

The fastest price appreciation happens in stage 1 and stage 3.

2) Acceptance stage 

More and more people gradually warm up to the idea that we are in an uptrend and the market should be considered “innocent until proven guilty. Stocks have been going up for awhile and the minor dips were short lived.

Between stage 2 and stage 3, there is usually a deeper market pullback, which tests the resilience of the rally, shakes weak hands out and allows for new bases to be formed. The deeper pullback is used as a buying opportunity by institutions, which missed the the initial stages of the rally and their purchases push the market to new highs.

3) Everything will go up forever

During stage one, most people are skeptical, because the market has just come from a high-correlation, mean-reversion environment and most are unwilling to see the ensuing change in market character. In stage two, investors gradually turn bullish for the simple reason that prices have been going up for a while. Analysts and Strategists are also turning bullish in an attempt to manage their career risk. In the third stage, most market participants are ecstatic, not only because prices have been going up for a while, but because they personally have managed to make a lot of money. Everything seems easy, the future looks rosy and complacency takes over proper due diligence.