Bull market tops are typically first marked by an unwinding of speculative excesses and investor psychology, cautions Jim Stack, a "safety-first" money manager and editor of InvesTech Research.
Our Canary (in the coal mine) Index — which tracks approximately 20 of the most overhyped, overbought, and overvalued stocks in the market today — has since plunged through both of its critical support levels. This is an indication that the peak in speculation is in place and that we may be in the early stages of the market topping process.
Our Canary Index has now lost over half of its value since its peak early last year, and the Index remains under heavy selling pressure. Looking back, it was the dramatic drop in the Interactive Week Internet Index, comprised of highly speculative technology stocks, that marked the beginning of the unwinding of the Tech Bubble in 2000.
Broader technical warning flags have also appeared in the big-cap momentum stocks, as well as our proprietary Negative Leadership Composite, suggesting that significantly rougher waters lie ahead as a monetary showdown looms.
While the transition from an overly accommodative Fed policy to a gradual tightening might seem innocuous, we fear the shift in investor psychology will not be gentle or harmless.
The frothy speculation and extreme overvaluation present in today’s stock market is directly attributable to the Fed’s sloshing liquidity and investors’ persistent FOMO (fear-of-missing-out) attitude.
Throughout this past prolonged bull market, the periods of maximum gains in the S&P 500 have coincided with Fed balance sheet expansion. Past balance sheet transitions typically lead to a market correction. And that could mean major trouble ahead .
Meanwhile, our defensive portfolio just got more defensive. Although our InvesTech Model Fund Portfolio was already 26% in cash, we recently increased that defensiveness with the addition of a 5% position in an inverse index (bear market) fund — Direxion Daily S&P 500 Bear 1X Shares ETF (SPDN). This is an incremental defensive hedge based on continued deterioration in the weight of the evidence
In addition, literally half our allocation (36%) is in more defensive sectors: health care, staples, energy, gold, and international. More importantly, these steps position the model portfolio for implementing additional bear market defenses if warning flags continue to increase.
