Are Stocks Climbing the ‘Wall of Worry?’

Wall Street has taken the government shutdown in strides. In fact, it almost seems like the government shutdown is just another brick in the proverbial ‘Wall of Worry.’ We need to ask, are stocks climbing a wall of worry to new highs?

The worst-case scenario is now reality. The government is partially shut down … but Wall Street isn’t too worried about it. In fact, stocks (NYSEArca: VTI) are up.

Are stocks climbing the proverbial ‘Wall of Worry?’

This so-called wall of worry wasn’t ‘built’ by the government shutdown. History shows that government shutdowns do not affect stocks (more below).

A look at sentiment shows that the wall of worry has protected this bull market like a medieval moat protects a castle. 

The chart below plots the S&P 500 (SNP: ^GSPC) against the percentage of bullish advisors and newsletter-writing colleagues polled by Investors Intelligence (II). 

Included is a 6-week average of the percentage of bulls to add a little more flavor and depth to the sentiment development.

Here are the two key points:

1) The S&P 500 (NYSEArca: SPY) is trading near its all-time high.

2) Investment advisors are relatively bearish considering how well stocks have done.

Here’s what we’d normally expect to see:

Nothing gets investors as excited as rising stock prices. Since stocks have been rising a lot, investors should be excited. But they are not.

Here’s what we’re actually seeing:

As stocks continue to rise, investors are turning bearish. Yes, investors are quite suspicious of the latest rally leg.

Just like a fire, bull markets need fuel. Suspicious or bearish investors are the fuel that keeps the bull market burning higher. 

Why? Bearish investors haven’t bought into the rally yet and are the only ones (potential buyers on the sidelines) that can (and usually will) drive prices higher.

Last week, the 6-week average of bullish investment advisors was closer to readings near market bottoms than market tops (red circles).

Here’s what this means:

I previously published an article titled ‘QE Haters are Driving Stocks Higher,’ and that’s exactly what’s happening.

It becomes more obvious if you look at the Nasdaq (Nasdaq: QQQ), Russell 2000 (NYSEArca: IWM) and S&P MidCap 400 (NYSEArca: MDY). Unlike the S&P 500 and Dow, they are all trading at new (all-time) highs.

Based solely on sentiment, stocks have more up side ahead.

What about the government shutdown? How does it affect stocks? 

A detailed look at all government shutdowns since 1980 offers a surprising conclusion. In fact, all eleven government shutdowns since 1980 coincided and benefited from a particular seasonal stock market pattern.

A detailed analysis of how exactly this affects the S&P 500 can be found here: 

How Government Shutdowns Affect Stocks
 
Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF

 

 

Optimism on the Rise – Should You “Fear the Cheer?”

A crowd follower does the opposite of a contrarian. Like a red light camera, contrarian indicators are effective because most people aren’t aware of them. But what happens when – as is the case right now – contrarian indicators go mainstream? 

In the first week of January investors shoveled $22 billion back into equity funds around the world. This is the second highest inflow on record reports Bloomberg.

Bullish sentiment of investment advisor and newsletter writing colleagues (polled by Investors Intelligence – II) jumped to the highest level since September 18, 2012 (the S&P 500 declined 9% thereafter).

Retail investors polled by the American Association for Individual Investors (AAII) are the most bullish they’ve been since February 9, 2012.

Am I forgetting something? Oh yeah, the VIX just hit the lowest reading in 72 months.

Investors are so bullish, it must be bearish for stocks, right?

Contrarian Gone Mainstream

It normally pays to fear the cheer. But a trap is only a trap as long as it remains hidden and extreme sentiment is only a contrarian indicator as long as it remains contrarian. Contrarian indicators gone mainstream don’t work (remember the much publicized, ultra-bearish Hindenburg Omen in August 2010?).

Extreme optimism alerts or “fear the cheer” headlines have just gone mainstream. A small sampling of Friday’s headlines is listed below:

“Where’s the wall of worry?”
“Why VIX’s recent plunge may be bad for stocks”
“Earnings disappointments ahead”
“Is the crowds cheery mood reason to fear the rally’s end?”

For the first time in quite a while the VIX, II, and AAII polls are delivering a generally bearish signal. However, the media skepticism caused by investor optimism may well negate the bearish contrarian implications (is there such a thing as an inverse contrarian signal?).

Even though the VIX is unusually low, the chart below shows that as of late a low VIX alone doesn’t automatically translate into lower stock prices.

How the Market May Trick “Inverse Contrarianism”

The media can change its tune on a dime and the market usually takes the route least expected. One way the market may shake out or convert the pessimistic optimists is simply by grinding higher. Nothing is as persuasive as rising prices.

Or, the market may decline a bit – make the bears feel safe – and then deliver another rally leg.

Whatever route the market chooses, I wouldn’t make any buy/sell decisions purely based on sentiment at this time.

Key Inflection Point Ahead

More gains in the form of a final push higher would harmonize well with my technical indicators and technical model, which sees a key inflection point just ahead.

This key resistance (I call it inflection point because the S&P 500’s reaction there should set the stage for weeks to come) is the same type of resistance level that pinpointed the 2011 market top and subsequent 20% waterfall decline.

Key inflection points like this always provide low-risk trade opportunities. Why? The potential for gains is so much larger than the risk of losses because you know exactly when you are wrong. You can go short with a stop-loss just above resistance or long once resistance is broken with a stop-loss just below.

The latest Profit Radar Report highlights this key inflection point along with actual trade recommendations.