Market Euphoria Is A Big Warning Signal

(Written by Bert Dohmen, contains excerpts from our latest Wellington Letter published August 25, 2024)

After the huge selloff in early August, due to the big unwinding of the Yen Carry Trade, the markets have staged a swift and sharp rebound off their August 5th lows. Many believe this is evidence that the bull market can continue over the next several months.

Is that because it’s the “path of least resistance,” or because it’s the easiest conclusion to come to given the big rally we’ve seen for the majority of this year?

Why is no one talking about the possibility of a bear market?

Everyone knows that bull markets are great and often quite easy to invest in. But bear markets are much more rewarding because stocks and bonds can decline so much faster in a bear market than they rise in a bull market. Remember that over the next several years.

As we wrote in our last Wellington Letter (August 4th), we believe we are likely in the final phase of the bull market.

But how did we get here? Let’s revisit the recent volatility we’ve seen in the markets.

Over the past several weeks we accurately predicted the tumultuous market action of July-August for our members. Below are just a few excerpts from our research services during that time for easy reference:

  • July 14thWellington Letter:

NEARING PEAK BULLISHNESS?: We have written in past issues how the current bull market phase would end: with only a few big well-known stocks rising, then there would be one last blast to the upside led by those stocks to turn the late investors bullish.

On a family trip, the kids always ask, “are we there yet?” We believe that we still need that final “hurrah” where even reluctant bears plunge in. That could come in August.”

  • Editor’s comment: On August 16th, nearly 1 month later, a respected analyst said on TV he is seeing signs of “euphoria.” This is very similar to what we wrote on July 14th (above).
  • July 16thSmarter Stock Trader: (warnings from the VIX, day of the top of July market rally)

“The volatility index (VIX) typically rises when the stock market declines, and vice versa. But not the past 2 days. Today the DJI was up a big 742 points. Therefore, normally the VIX should have been down. But instead, the VIX rallied.

Entities using the VIX, mostly hedge funds, were obviously not acting as if they thought the market rally would last. These are very sophisticated players. Therefore, consider this a preliminary “warning” for the rally.”

“Right now the market has become very overbought and therefore the rally is vulnerable.”

  • Editor’s comment: a swift market correction started the very next day, the NASDAQ Comp plunged 15.1% and the S&P 500 plunged 9.7% into the August 5th lows
  • July 17th Smarter Stock Trader: (day the markets started the July-August correction.)

“We had written that we expected a weak market in the second half of July, to be followed by a ‘Last Hurrah’ rally in August.”

  • Editor’s comment: the current rally qualifies as a that kind of rally.

Stock Market Bottom & Summer Rally forecast:

“The DJI plunged on Friday (August 2). At the low the DJI was down an eye-catching 989 points…However, the DJI is often used as a short term trap.

Although the market indicators show a temporary bottom will occur this week, and generate a bounce, it is not a buying opportunity. The inexperienced traders will try to jump in and “buy the dip” this coming week.”

“Short term there should be an oversold bounce, possibly hyped as a “summer rally.” After that, the selling should recommence.”

Bear Market Forecasts:

“For the next several months, perhaps till late October, we are bearish on most stock groups. But that doesn’t mean there won’t be sharp short-term rallies.

The bear market in stocks is starting. We wrote that some indices would make new highs, but those would be false upside breakouts. That means they are engineered to trap the bulls.”

“Everyone, including individual investors, money managers, and short-term traders, are invested “up to the gills.” There is a lot of selling still to be done.”


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On Monday, August 5th, the shocking news was that the “Yen Carry Trade” was imploding. This was an ultra-leveraged trade by the biggest currency traders in the world. The margin calls caused massive selling of stocks and currencies, which was called a crash by many.

We wrote two days later (Wednesday, August 7th) in our Smarter Stock Trader

“We believe Monday (August 5) could be the short term bottom for most stocks, although specific stocks with questionable fundamentals are likely to be weak.”

So far, so good as the markets have rallied sharply over the past two and a half weeks with the NASDAQ Comp soaring 13% and the S&P 500 rising roughly 10% since their August 5th bottoms.

CONCLUSION: The market is following our script of the past several months to a “T”. We had expected a poor July to be followed by a big rally in August. July brought the plunge, which was so strong on such high volume that at first we thought perhaps the weak fall period we had forecast came earlier than we originally expected. 

Now our work suggests that the rally will continue into late August. And then comes September. Bullish sentiment, which plunged during the July-August selloff, has now returned to highs seen before other recent market declines. Therefore, this is the time to be cautious and reduce exposure.

As you read above, we believe this current rally may be the “last hurrah” for the bull market, where some indices will make new all-time highs in order to trap the majority of investors. In fact, the NYSE Composite, SPEW (equal weight S&P 500) just made new record highs.

The DJI also made a new record high this week, which should garner more excitement among investors before the plug is pulled. The peak could come next week after Labor Day.

As we get into September, the bears will have plenty of opportunities, similar to what we saw in late 2021, just ahead of the last bear market.

In an overvalued stock market, measured by a variety of yardsticks, a serious bear market may eventually bring back single-digit P/E ratios on many stocks. But that will have to wait till 2025-2026.

Wishing you successful investing,

Bert Dohmen
Founder, Dohmen Capital Research

 

 

 

 

 

 

Authored by Dohmen Capital Research via ZeroHedge August 30th 2024