Why the Market’s Heights are Unrealistic

Why the Market’s Heights are Unrealistic image 010813 PC leongMarket’s Heights are UnrealisticInvestors continue to view this market with an extremely bullish view.

The investor sentiment readings on the NASDAQ have been well above a bullish 90% for more than three weeks. This means stocks could move higher.

The evidence is on the charts.

The S&P 500 traded within 1.22 points of 1,700 when it hit another record high on July 23. On the same day, the small-cap Russell 2000 also traded at a record high. This index is up a sizzling 24% this year, and we still have five months to go; that’s 41% on an annualized basis for the Russell 2000.

You all know I favor small-cap stocks, but the advance in the Russell 2000 so far is somewhat alarming.

Take a look at the chart of the Russell 2000 below. You will notice I have drawn three consecutive flag formations, as shown by the blue parallel lines. The first and second flags were subsequently followed by a swift rally. The Russell 2000 is now in a tighter flag. The question is: will we see yet another rally following the current hesitation?

Why the Market’s Heights are Unrealistic image Russell 2000 Small Cap Index ChartRussell 2000 Small Cap Index Chart

Chart courtesy of www.StockCharts.com

There’s a good chance the Russell 2000 could move higher, but at the same time, I feel the advance has been too rapid and stocks could stage another correction and produce a buying opportunity, based on my technical analysis.

The current bull market has been all about easy money by the Federal Reserve elevating the stock market and the lack of any viable investment alternative—unless you like the miniscule yields from U.S. Treasury bills.

The move in the Russell 2000 implies the U.S. economic recovery is faring well. But unless you feel that 1.8% gross domestic product (GDP) growth in the first quarter, and perhaps even lower in the second quarter, is good, you likely think the Russell 2000 is ahead of itself and vulnerable to some selling. (Read “How to Make Sense of This Mixed-Up Market.”)

What I’m seeing is a market that is moving higher, dragging along with it even those companies that have horrible underlying fundamentals. In my view, the buying of bad companies is euphoria. The current feeling among participants is that nothing can go wrong, stocks will move higher.

Yet we know that much of the buying is being done by the retail money. Just take a look at the low volume that has characterized the stock market for the majority of the year.

Much of the pro and institutional money has declined as the stock market continues to move to new record high after new record high.

The overextension in stocks is real. I still favor stocks, but you really need to take some money off the table and look for a potential opportunity to buy on the horizon if the market corrects.

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