Mark Twain, “History doesn’t repeat itself, but it does rhyme.” The catalysts may differ for both bull and bear markets, but the themes giving rise to these trends tend not to change.
Many of these themes that we see in the markets time and time again are behavioral. Investors who have been sitting out this party for the last five months are experiencing the pain of watching from the outskirts as asset prices appreciate. These investors are feeling regret that they have not participated and are starting to get sucked in.
The longer we hold these levels, the more investors will be sucked into this market, which has helped take out resistance. Investors’ risk tolerance increases because they are less concerned with losing money than missing the appreciation. We are starting to see some risk aversion go away, slightly, and people are finding it hard to believe they will incur losses.
Six months after our first strong buy on the S&P 500 at 1,418 and a 17% gain, we are finally triggered to an overbought signal on the S&P 500. Please see the chart linked below.
However, we did some analysis with our countertrend indicator and found some interesting findings. Looking back at the last 15 years, the most overbought market reached a countertrend reading of.-74. Currently, we sit at a -.73. During this period, the maximum gain on the S&P 500 from a -.73 to a -.74 was 1.45% with a 3% pullback 30 days after hitting -.74.
However, going back 25 years, the most overbought market was 1995. The S&P 500 ended up 34% that year. From January to May, the S&P 500 was up 14% compared to 17% over the same time period in 2013. In 1995, the S&P 500 remained overbought from May 8 to Jan. 8, 1996, gaining another 20% from May 9 to Dec. 31. During this 20% gain, the biggest pullback was 3.5%. In 1995, the S&P began the year trading at 15 times earnings. GDP was sub 1%, the U.S. deficit was at its highest level ever, and Mexico was about to default on its debt.
Point being, 1995 was climbing a wall of worry, and the economic climate was not stellar. In 1996, we had another great year, with the S&P 500 up over 20%. It is impossible to determine if 2013 will repeat history. But don’t assume the market has to correct any time soon even if the market becomes the most overbought market in 25 years.
We have seen over the last four weeks the cyclical names rally hard with financials, industrials and energy leading. Back on May 8, we talked about energy as a way to play sector rotation. On Monday, we saw a significant jump in strength in this sector and would remain long for now. See the chart page for our Energy Sector Strength.