Euphoria Continues As Investors Beg For A Correction

Stock Market Still Overheated

There have been many odd records this year which you normally don’t hear about. That’s what happens when the S&P 500 hits a new record almost every day. I’m not exaggerating with that statement. As you can see from the chart below, the S&P 500 hit a new high in 12 out of the first 15 days of the year. It’s the highest number of new highs since at least 1970. I wouldn’t necessarily trade off this information because many years the market didn’t start near a new high, so it wasn’t possible to achieve such performance. This is just another piece of information which shows the market is in a euphoric stage. Adding to this point, the S&P 500 has been above the 200-day moving average for 396 days. That’s the 2nd longest streak since 1957. The longest was 475 days from 2012-2014.

The chart below shows the Wells Fargo Animal Spirits index which, unsurprisingly, is near the highs seen before previous recessions. We’re at an unusual place where I see investors begging for a correction. If you are bullish on the economy and earnings, you want stocks to go up slowly and have normal corrections. The speculation in stocks is probably the biggest potential catalyst for a sharp correction since earnings estimates are headed higher and global trade growth has been strong. There’s a sinking feeling that volatility is like a spring, where this extremely placid action is about to lead to a bout of volatility. The fact that so few investors have witnessed any meaningful correction can cause a knee-jerk reaction to a sell-off. If selling catalyzes more selling, the market can easily fall 10% or more. It’s not as if valuations would be compelling after stocks fell 5%. The main trade is based on momentum. When it ends, the house of cards could crash even without a recession.

One way to spook investors would be a sell-off in which most of them don’t have protection. As you can see in the chart below, that’s the exact situation we find the market in as the net percentage of investors who said they have taken out protection against a sharp correction in equities has fallen to the lowest level since 2013. Investors only decide to buy puts after they need them. As you can see, put buying was high in 2008 and 2016. The one time this wasn’t a contrarian indicator was 2009. That was the beginning of the bull market. The current market is far from that.