Warning investors about a potential upcoming crash is a risky exercise in finance and there are very very few analysts who dare to do it.
However, in exactly the same way that storm warnings issued by meteorologists allow citizens, cities, and countries to protect themselves in case they hit them, Crash Warnings should be the MOST IMPORTANT message analysts should send to investors to warn them of their possibility.
In exactly the way, in meteorology, there are early indicators that point to the formation of a storm, without the certainty that it will materialize, in finance, there are early indicators that warn that the probability of a crash has increased to worrying levels.
In our recent article titled MOST DANGEROUS PHASE AHEAD, we warned investors that the conditions were falling in place for, at best, a severe correction coming into the end of June, and most likely, a severe second leg of the bear market to unfold.
The widely shared consensus view is that US equities will not fall before the upcoming US Presidential elections 100 days from now.
But this wishful thinking conclusion is based on past elections history and does not take into consideration the fact that there has never been a global deflationary shock of the magnitude of COVID-19 in any past elections, such a massive surge in unemployment and unprecedented social unrest and soul searching before.
Today, we are warning investors that a SUDDEN CRASH in equities is becoming a possibility that cannot be ignored …
Our warning is based on sentiment indicators that are flashing bright red warning signals …
We list them below :
EXTREME VOLATILITY AND TIME COMPRESSION
The most unusual characteristic of the past four months has been the SPEED and MAGNITUDE of both the fall in February – March 2020 and the rebound in April – May 2020.
NEVER in its history, the Dow Jones INDUSTRIAL INDEX has lost 35 % of its value in one single month, and NEVER in history, the same index has rallied by 43 % in the space of two months, making it the strongest rally since the 1950s.
These extremes simply reflect the EXTREMES OF UNCERTAINTY that are currently prevailing due to the exceptional magnitude of the short term and long term economic consequences of COVID-19 on the world economy and corporate earnings.
The sharp fall and rise of equity markets have been entirely due to unprecedented swings in investor’s sentiment, falling to extreme bearishness at the time of the outbreak, and then rising to extremes of optimism as lockdown measures were lifted and economies started showing signs of life.
If history and behavioral analysis are any guides, the next shift in sentiment towards bearishness will be as fast and the fall in equity markets could be even sharper as hopes for better times will have been quashed for good.
It is as if the brutality of COVID has exceptionally compressed time, and market phases are unfolding at a speed and magnitude that usually takes several months or even quarters in normal circumstances
Commonality is the fact that all markets around the world and all asset classes are moving in tandem, rising and falling together, with no distinction being made between potentially different underlying situations.
Commonality is a very important tool of technical analysis because it confirms that trends and sentiment are all confirming and self-feeding each other, instead of being isolated and therefore an exception in the norm.
In the past four months, each and every stock market in the world, save for China domestic equities, have been moving up and down with the same violence, each and every bond market has behaved in exactly the same way and each and every currency has fluctuated against the USD, the currency of last resort, in tandem.
Moreover, Gold and precious metals have also moved in tandem and sync with the global sentiment.
What commonality means in this case, is that when the markets turn, there will be nowhere to hide, apart, maybe, in Chinese domestic equities.
Another extremely unusual feature of the past four months has been the SPEED and EXTREMES in the shifts of investor’s sentiment.
The following indicators from SentimentTrader are most telling.
Along with prices, confidence has stormed back from the depths of pessimism, especially among those who have a tendency to be most bearish near price lows and most bullish near price highs.
From a record low reading in March, sentiment has cycled well into extreme optimism in a record amount of time and is now back where it was prior to COVID-19 at the high of the market just before the sharp downdraft of February March
Another extremely worrying indicator is the bullishness of investors on Tech stocks, the leaders of the entire secular bull market and the most determining components of the global indexes.
Sentiment towards tech stocks is at record highs and at the highest level since the dot-com bubble. The last – and only – time in history tech optimism was this extreme was at the peak of the dot-com bubble.
`BREADTH AND TECHNICAL SIGNALS
Breadth is the measure of participation of given stocks in an index or market in a global index move. When a large percentage of the index is participating in the ove, the move is broad-based and considered to be solid while if only a small percentage of the components are in the same trend, the move is considered to be weak and less sustainable.
What has been truly exceptional in the past four months have been the unprecedented level of BREADTH in BOTH the down and up phases, but even more so, the SPEED at which breadth has built-up with the turns.
In the week before last, 95 % of the SP500 stocks were delivering BUY signals on their MACDs, giving a very positive signal…
Last week, the situation has completely changed… 56 % of the stocks in the SP500 have now delivered SELL signal in just one week, THE HIGHEST LEVEL EVER…
The indicator for the NASDAQ paints a similar picture, with the indicator where it peaked just before the bursting of the Dotcom bubble in 2000.
From a more traditional technical analysis standpoint, we are currently sitting at CRUCIAL LEVELS …
The SP500 is marking a lower high.
If last week’s significant reversal is confirmed, the SP500 will have recorded a major LOWER HIGH, confirming that the Bull market is over and that the second leg of the bear market is starting.
The NASDAQ may be marking a significant double top
If the NASDAQ does not hold and progress above 10’000, then a major DOUBLE TOP will have been recorded indicating that the entire bus market is over and that stocks are starting the second leg of a major bear market.
A FAILED ATTEMPT at a new all-time high would just confirm that buying has been exhausted for good and that selling will now kick-in, in a strategic way.
SPECULATION AND EUPHORIA
What clearly transpired in this phenomenal rebound of the past few weeks is that one of the most active components of trading was done by individual investors through their newly opened online brokerage accounts with Robinhood, e-trade, and all the online trading apps that are now available.
The chart below shows the unprecedented and massive jump in online account openings and activity in the past two months.
Far more worrying is the massive SPECULATIVE BULLISHNESS of these small traders who have been using the option and futures markets to leverage their long positions to extremes never seen in the past apart from the peak of the dot.com bubble
Over the past few weeks, the increasing amount of speculative activity among options traders, particularly the smallest of them that transact 10 contracts or less, has been spectacular and has been sky-rocketing last week, as those small traders have taken the correction as an opportunity to increase their bullish bets even more.
Speculation has reached extremes never seen in the past, not even in 2000
and in absolute terms, they have spent nearly $4 billion more in premiums on these calls relative to the premiums they paid on puts, a level never seen in history.
Each and every indicator we follow is flashing WARNING SIGNALS that cannot be ignored by investors, and our mission is precisely to warn investors that something drastic may be about to happen…
The traditional indicators are telling us that we have reached extremes of bullishness that usually point to a sharp downdraft ahead…
Our base scenario is that we are quickly nearing a turning point and that a correction is about to unfold very soon…
Considering the violence of the shifts in breadth, sentiment, and time compression, of the past four months, and the fundamental and lasting damage that COVID-19 will end-up causing to the world economies, corporate earnings and the social fabric of some countries such as the USA,
We lean more towards the unfolding of the second leg of the bear market than a simple 10 to 15 % correction…
WHAT REALLY LEADS US TO WARN INVESTORS ABOUT A POTENTIAL CRASH IN EQUITY MARKETS IS THE UNPRECEDENTED LEVEL OF PARTICIPATION OF NEWCOMER INDIVIDUAL INVESTORS IN THIS LAST RALLY …
AND THE EXTREME LEVELS OF SPECULATION AND BULLISHNESS OF THIS NEW CATEGORY OF INVESTORS…
WHEN THEY’LL START LOSING MONEY AND RUSH FOR THE EXITS, EQUITY MARKETS WILL FALL IN A VACUUM…
AND THE DOWNTREND WILL BE ACCELERATED BY ALGORITHMIC TRADING …
AND BY INSTITUTIONAL INVESTORS HAVING HAD THE CONFIRMATION OF A BEAR MARKET AND START OFFLOADING THEIR LONG TERM HOLDINGS IN OVERVALUED MARKETS …
A Perfect Storm is building up …
it may not materialize …
but if meteorologists do not warn
about its possible occurrence,
WHO WILL ?