Extreme Optimism Confirms A Short-Term Top In The Markets

Chris Vermeulen


Let’s start this post with a great quote from the legendary investor Warren Buffet: “Be fearful when others are greedy, be greedy when others are fearful”.

Since the US Presidential elections, the SPX has risen from 2139.6 on November 8th, 2016 to 2271.7 on December 13th , 2016 which constitutes a rise of 6.17% within just over a month.

The rise has been fueled by the expectations of tax cuts and enormous fiscal spending intended to boost inflation. In turn, the FED is most likely to raise rates at a quicker pace, which has sent the US Dollar Index to 13-year highs.

With this in the background, almost everyone who invests have all gone long in hopes that the markets will continue to rally. After all, there are many who have forecasted lofty targets of 3000 and above on the SPX for this year. This extreme optimism has led to the markets being skewed on the long side.

Evidence Of This Extreme Optimism

Another proof of point of this extreme confidence is shown in the double digit +10 score in the Gallup’s US Economic Confidence Index, which is not only at the highest level since the index started in 2008. However, it is also the first time that the index has hit double digits, which were in the negative only a few months ago.

U.S. Economic Confidence Chart

Similarly, the Rydex Fund data proves that the mutual fund traders have abandoned the short side of the fund and are getting aggressively long.

Currently, the bearish fund assets are at their lowest level.  For every $1 invested in the bearish fund, the bullish fund has attracted $20 worth of investments.  

The last time that this happened was at the end of 2015, after which the markets went through a sharp correction period during the first two months of 2016. Rydex funds are a fantastic gauge on what the average market participant is doing and feeling – Contrarian Indicator!

Considering the timing and the cyclical nature of the markets, I believe that a similar pattern will play out sometime during the second half of 2017.

For this, we need to see whether the bullishness is by the smart money or by the dumb money.

The smart money is playing it safe, whereas, the dumb money is close to the highest level of bullishness that it has experienced in over a year.



The VIX chart below indicates that the markets are not adequately protected on the downside. 




The charts indicate how the markets are skewed towards excessive optimism.

What this means is that when everyone has already invested, in the markets, and there are no buyers left, the markets will turn and turn down sharply. I believe this  will start within the second half of 2017.
 
There will be a quick rush to exit and consequently this will lead to a sharp fall in the index. All the money which will leave the equity markets must find another ‘asset class’ in which to invest.

The money will flow into the beaten down ‘safe havens’ of bonds and gold.
 
Hence, both TLT and GLD should see a sharp rebound in 2017…just as we expected in our December Gold Marmet Forecast.

In Conclusión

I am not calling for a major top in the market yet as Trump “Trumped” the bear market that was starting. However, a short-term top is likely, which is almost certain to shake out a number of bulls.
 
The correction in stocks and the rally in GLD and TLT most likely will surprise many
 
The next year will offer many such opportunities to make profits. To be sure I will let you know in advance whenever the trend is about to change for both swing trading and our long-term investment portfolio.

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