Editor’s note: This article was first published in December 2012; the IBEX 35 levels, the bull-market forecast for 2013, the retail-led rally of summer 2012 and the expected end of Spain’s short-selling ban reflect market conditions at that time. The two charts discussed in the original article (a market-sentiment cycle and a chart of the XLY and XLP ETFs against the S&P 500) could not be recovered.
When I saw all the European stock markets in the green this morning, and in particular our IBEX 35 breaking strongly through resistance at 8,240 points, I was surprised, because the economy is hardly producing figures that invite optimism.
Quite the opposite: we are still gripped by pessimism. Then again, as an editor at Rankia rightly reminds us, markets are born on pessimism, grow on scepticism, reach their bubble on optimism and die on buying euphoria.
Most analysts were warning of a sharp correction (myself included), and we are all puzzled by this bullish behaviour. If we follow that chart, we would now be in the scepticism phase, which in the same way would mean that 2013 would be a bull year for stock markets. Of course, there is some doubt as to whether we are already living through a “small retail euphoria”. A doubt that would supposedly be cleared up by this other chart, very well spotted by Uxío Fraga, editor of Novatos Trading Club.
What this chart basically shows is that smart money, the strong hands of investing, is not afraid.
XLY (the first chart below the S&P 500) is an ETF that tracks the consumer discretionary sector, a cyclical sector that rises when smart money backs it. Smart money only commits to this sector (and other cyclical ones, such as the car industry and so on) when it expects prices to rise or when there is no fear. When there is fear and the money can’t leave the market, it moves into counter-cyclical sectors such as consumer staples, whose index, represented by the XLP ETF, is the one at the bottom.
What these charts show is that consumer sectors are strong (both XLY, the aggressive one, and XLP, the fearful one), but above all that smart money is in XLY. That means the people who know most are fearlessly putting their money into one of the first sectors to sink in a recession. In other words, there is no fear.
But be very, very careful.
This is the point at which retail investors could become afraid of being left out of the market and get carried away by buying euphoria. And that is where the biggest stock market massacres of retail investors happen.
The normal pattern in markets is for the big investors to buy, signalling the end of a downtrend. Retail investors would then buy, putting their money in on top of the big investors. This time it hasn’t been quite like that: in the summer it was us, the retail investors, who pushed the market up against all expectations, helped by the closing of short (bearish) positions. Smart money came in late, and the big players still hold bearish positions in listed companies.
There are now two risks that nobody can predict. One is getting in and then, when the short-selling ban (then in force in Spain) ends, watching the selling go into overdrive at the slightest doubt. The other is staying out and missing the start of a trend that, on the charts, is clearly bullish.
On top of this, practically every stock is forming technical reversal patterns. That is, they are breaking through resistance levels, and some are hitting new all-time highs.
In short: technical analysts were expecting a sharp correction. I’m more of a fundamentals and macroeconomics person, and I was expecting the mother of all stock market crashes. Have we all got it wrong? We might have… although…
Featured image: Eva K. / Eva K, CC BY-SA 2.5, via Wikimedia Commons.
