The market has been on a tear ever since its huge 35% correction in March 2020- S&P index drop from 3400 to 2200- due to the Covid 19 pandemic. It has more than doubled from the bottom to its current level at 4650.Â
So what’s the outlook ahead?
Is it on a never-ending trajectory to the moon?
We will be looking at 6 indicators and the chart of S&P to give us some indication if things are getting way too hot that will lead to the imminent meltdown.
The power of the Fed printing machine has worked wonders. But is the market getting too complacent?
Buffet Indicator
Source: www.currentmarketvaluation.com
The Buffett Indicator is defined as the value of a country’s publicly traded stocks divided by its gross national product. The greatest investor of our lifetime, Warren Buffet, have used this indicator to assist him to gauge where the valuation of the market stands at any moment in time.Â
We are now way off the charts and looks excessively overvalued. If the market just reverts to the historical trendline, it could easily be a 50% correction.Â
Berkshire cash holdings of 149 billion are also at their all-time high and constitute around 17% of their total assets of 873 billion dollars.
Shiller Cape Ratio
Source: multp.com
The next indicator we are looking at would be the Shiller Cape Ratio. It is the cyclical adjusted price-earnings ratio.
Due to the cyclical nature of the markets, an outlier pe ratio (a recession for the year) could distort the analysis of the market valuation.
Thus, Professor Robert Shiller came up with the CAPE ratio to adjust for cyclicality- taking the average of 10 years PE- and hence portray a more accurate picture of the valuation of the market.
The current Shiller Cape Ratio is only surpassed by the dot com bubble in 2000. We are not in the value zone.Â
Some explanation for the high ratio could be due to the ultra-low interest rate environment that would enhance the valuation of the market– cash flow is discounted at lower rates which leads to a higher valuation.
With inflationary effects creeping in, where the US recently have hit an inflation figure of 6%, the days of low-interest rates might not be a certainty in the future.
VIX- Volatility Index
Source: Yahoo finance
VIX is a measure of volatility or fear factor in the market. It is derived from the implied volatility of the S&P 500 options. There is a negative correlation between price moves and the VIX.Â
The VIX tends to increase when the market falls. The VIX has been recently showing some strength and has reached around the 30 levels just this week but it has since retraced back to the low 20s level.Â
A break above the 30 levels could signal the start of a market correction which is possible as the VIX seems to be building up momentum at the moment.
Fed Balance Sheet
Source: tradingeconomics.com
Looking at the Fed Balance Sheet, we could see the US money printing machine at full throttle. The amount is 8.66 trillion which have more than doubled since 2020.Â
The Fed balance sheet comprises mainly of treasuries that they have purchased through money printing.Â
The huge amount just highlights that things might be out of control and the only way to keep the party going is to print more and deleverage using this approach. Moreover, the government debt is also escalating to new records, it currently stands at 28 trillion dollars.
The critical question that we have to ask ourselves would be when will the confidence of US dollars be eroded with the insane money printing machine at work?
Our take is when we see China’s treasuries holding fall below the 1 trillion mark- have been holding slightly above 1 trillion through the years- that could be a marker for us to be cautious.
The Commitment of Traders for S&P 500
Source: www.barchart.com
The commitment of traders indicator is to gauge the positioning of the different players in the futures market. At this juncture, the large speculators which we deem as the smart money is still net long on the S&P 500 futures with an increasing position sizing.
This could mean the rally might still have legs.Â
AAII Investor Sentiment Survey
Source: AAII.com
The last indicator we will be looking at will be the AAII investors survey sentiment. It measures the mood of individual investors.Â
Based on the latest statistics, it is showing the highest neutral sentiment in 2 years. The AAII sentiment is usually used as a contrarian indicator where an ultra bullish sentiment would be taken in negatively and a slant towards a market correction could be round the corner.
Based on the current reading, it would be inconclusive.
Chartist Point of View
Source: investing.com- S&P 500 chart
The trend is your friend. The uptrend of the S&P 500 is intact.Â
First hints of weakness would only surface if it breaches below 4500 levels. The critical support would be at 4200-4300 levels which would be the first target if S&P retraces.Â
A deeper correction could be on the cards if the 4200 level does not hold, a medium-term target could see the S&P 500 testing the 3500 level.
For now, as long as 4200 holds, we are still bullish as the uptrend is still intact.
Summing Up
In this write-up, we took a look at 6 indicators to gauge if the S&P 500 is looking peakish. They are namely:
- Buffet Indicator
- Shiller Cape Ratio
- VIX
- Fed Balance Sheet
- Commitment of Traders
- AAII Investor Sentiment Survey
The first 4 indicators are showing signs of the market reaching peakish levels with the indicators reaching levels that are way above their mean or even reaching all-time highs.
However, as John Maynard Keynes famously quoted, “Markets can remain irrational longer than you can remain solvent.”
As for the Commitment of Traders, the smart money is still net long the S&P 500 while the AAII Investor Sentiment Survey is not showing any conclusive contrarian angle.
Finally, the charts are still showing the uptrend is intact and we will be on the defensive when S&P 500 breaches the 4200 level.
A piece of advice would be if the crash comes round, it could be fast and furious.
So with the market looking peakish, it is wise to have an allocation to gold as a defence mechanism. Moreover, gold is trading at a reasonable level. With the latest news of MAS increasing their gold pile first time in decades, it further lends weight to this thesis.
Disclaimer:
The content here is for informational purposes only and should NOT be taken as legal, business, tax, or investment advice. It does NOT constitute an offer or solicitation to purchase any investment or a recommendation to buy or sell a security. The content is not directed to any investor or potential investor and may not be used to evaluate or make any investment. Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stockbroker or financial advisor.
