2021 has certainly started off interesting. From Reddit readers chasing the most heavily shorted stocks, to the new administration discussing more stimulus, investors have had plenty to deal with. A market review seems appropriate as the bulls seem to remain bulletproof even as the mania grows.
Last Charge of The Light Brigade
One thing this market has become known for is its resilience. Regardless of the event, “hope” combined with plenty of Central Bank interventions has kept markets pushing higher. But, all good things do come to an end, the only question is the timing and the event. Importantly, what history tells us is that it is the Federal Reserve that has always led the “last charge of the light brigade.”
For those unfamiliar with the story, the “Charge of the Light Brigade” was a charge of British light cavalry led by Lord Cardigan against Russian forces during the Battle of Balaclava in 1854, during the Crimean War. Lord Raglan, the overall commander of the British forces, had intended to send the Light Brigade to prevent the Russians from removing captured guns from overrun Turkish positions. Such was a task that was well-suited to light cavalry.
However, due to miscommunication in the chain of command, the Light Brigade was instead sent on a frontal assault against a different artillery battery, one well-prepared with excellent fields of defensive fire.
Although, the Light Brigade reached the battery under withering direct fire and scattered some of the gunners, the badly mauled brigade was forced to retreat immediately. Thus, the assault ended with very high British casualties and no decisive gains. War correspondent William Russell, who witnessed the battle, declared:
“Our Light Brigade was annihilated by their own rashness, and by the brutality of a ferocious enemy.”
Such is the current market environment. Investors, much like the British Calvary, face rather daunting odds of long-term success. With a market that is overly bullish, overly complacent, and excessively valued, outcomes those that charged headlong into the battle have often suffered serious injuries. As the chart below shows, “bears” have gone into complete hibernation.
Who is Left to Buy?
Of course, one of the overriding questions is who is left to buy. With equity investor equity allocations at the highest levels in years and cash levels at record lows, such would suggest there is a diminishing pool of buyers to support markets.
The chart below shows the ratio of Rydex bullish to bearish assets. While not an all-encompassing survey of investors, it does provide a decent sample size for our analysis. The more extreme exuberance of investors has pushed the market well above the long-term bullish trend. It would currently require another 30% drop to close that gap, just as we saw last March.
But it isn’t just retail investors that are effectively “all-in” the market. Pension funds, which have substantially larger holdings than retail investors, are sitting on their lowest cash levels…. ever. (Charts courtesy of SentimenTrader.com)
Mutual funds, likewise, are also at record low levels of cash.
The point is that with investors “all-in” and leveraged, when a correction occurs, such has the potential to be exacerbated by the rapid unwinding of positions.
Of course, with investors chasing the most heavily “shorted” stocks, which are stocks with the worst possible fundamentals, it is clear the bulls feel “invincible” to any type of correction.
The invincibility is evident in the amount of speculative call option buying by retail investors, which dwarfs anything seen in previous market history.
In the short-term, which equates from a few days to a few weeks, markets are sentiment-driven. None of this means the markets will “crash” tomorrow. As John Maynard Keynes said:
“The markets can remain irrational longer than you can remain solvent.”
However, just as important is what Bob Farrell once quipped:
“Investors buy the most at the top and the least at the bottom.”
Market Review – Daily Chart
As shown, the S&P Index is currently overbought and trading significantly above its 200-dma. The short-term correction at the end of January did little to alleviate these conditions. However, with the Bollinger Bands narrowing, the market could trade higher over the next month.