Time to run or jump in?

“Should I sell all my stocks now?” This is kind of question I have got from a few friends these days. It had been really universally pessimistic in the past two weeks till early this week. Based on the chatting groups’ messages, I get a sense that a lot of people feel very depressing about the stock market right now and many were even saying that we have reached a major top and this correction should mark the beginning of the end of the 10 years bull market. And of course we are heading to much lower lows in the months ahead. Of course they may be very well right but as a contrarian I have a different opinion. Yes, the market will reach its unavoidable top and  go much lower at some point but I don’t believe it is imminent in terms of months. On the contrary, I think we will see new highs many times and a lot more from the recent tops before we reach to its maximum for this bull run. Let me explain.

I hold the view that bull market does not just die of age. Indeed this gigantic bull run has lasted for 10 years now and we are for sure very close to its top than bottom. But for its final ultimate top, I personally use two main indicators to gauge. First is the sentiment euphoria.

If you don’t know this famous maxim, you must try to inscribe it onto your heart:

 "Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”

“The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell."

 

Sir John Templeton

No one has probably described how the life of a bull market better than the legendary investment icon Templeton! So typically a bull market ought to die when there is blow-off euphoria developed. We have seen two examples in the recent history. In late 90s everyone wanted to jump in to catch up with the unstoppable dot.com frenzy. I was not in the US yet but I got investment newsletters in Europe to advise me that Intel would go up to $500 soon. Basically anywhere you go, you would get some stock tips even from a taxi driver. Many just quit their job as they thought they could make enough for their life from the stock market. This is kind of euphoria typically seen at a major top! Similarly in the mid 2000s, we saw another huge euphoric sentiment developing and this time for the housing market. I believe in 2007 I saw ads floating around calling people to sign up for free housing hunting trip from New York to Florida. Yes, at zero cost such a trip! Typically this kind of extreme euphoria will lead to a Melt-up of the stock market during a short period of time when a FOMO is developing and everyone wants to jump in. We definitely haven’t seen this phenomenon yet!!

Then the yield curve inversion. I have talked about this in details and you can find it here if you still don’t know what it is all about. This is very reliable early warning signal for an upcoming bear market to come and usually warns us 6 months to 2 years ahead of time. Ideally and hopefully we will see the yield curve first, followed by a Melt-up phase with extreme euphoria later. That will probably sort of “confirmatory” signal that a recession will finally come. I think we are far from seeing it at the moment.

So what to do now? Where it always depends on your timeframe. In the very near term, i.e. a couple of weeks, don’t be fooled by a seemingly rather strong rebound and rush to jump in like what we saw on Tuesday. I think the chance is still very high that we may likely see another retesting of the recent low around 2720 and it could make you sick again if you are chasing highs for now. It is very important that low is kept but of course there is no guarantee that it will be. However, based on historical data I have seen, I think the chance is also very high that this low retesting will be kept with positive momentum created that will pave a way for a more solid year end rally. You may not know yet but this recent crash has caused an extreme oversold condition not even seen with the January crash: the sentiment indicator, RSI dropping below 30. Someone tested the past 3 decades data and found that there were only 6 times occurring previously with such a low RSI for S&P. Now this is interesting to note that each time, S&P jumped back significantly higher in the following 3 months with an average of 8% gain. If this time we follow the same path which I believe we will, we should comfortably see a new high by the year end. But as always there is no assurance whatsoever. Tomorrow I will share an idea what may be an ideal sector to ride for the coming year end rally. Stay tuned!