Why to ‘Never Short a Dull Market’

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by: Nicholas Vardy

For all the handwringing about why you should “sell in May and go away,” both U.S. global stock markets have had a very strong last six weeks.

This has sent the “permabears” crawling back into their caves in Montana, even as their clients continue to suffer for their “permabull” calls on gold.

But even the few bulls the financial news channels could round up over the past few days struggled to explain the S&P 500’s relentless march to 2,000. Hedge fund maven David Tepper also recently backtracked on his cautious view of U.S. markets.

So why the sudden change in mood?

One tip of the hat goes to European Central Bank (ECB) President Mario Draghi, who just introduced a very proactive set of stimulus policies at this month’s ECB meeting.

Throwing everything he could at Europe’s deflation problem, Draghi lowered the policy rate, lowered the deposit rate and launched long-term refinancing operations — a trifecta of simultaneous stimulus measures that took the market by surprise.

Recall that Draghi has had success in kick-starting financial markets before. One instance occurred in July 2012 when he promised to do “whatever it takes” to save the euro.

Meanwhile, U.S. news has been solid. Economic growth has picked up strongly after a Q1 hiccup. A strong labor market report, combined with good May vehicle sales, suggests that the U.S. economy should expand near 4% in Q2. That should help boost earnings and support a continuing stock-market rally.

Indeed, U.S. stocks remain extremely strong, even as the S&P 500 hit four consecutive new highs. Even the Russell 2000, which tumbled more than 10% in late March and early April, has recovered most of its losses.

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Positive Sentiment and Weak Technicals

Frankly, all of this terrific news has me a bit worried over the short term.

I study many market sentiment indicators to gauge the temperature of the market. And frankly, all are screaming “extreme greed” at levels I have not seen since the middle of 2013.

There are other worrisome signs as well.

Two days ago, I saw the word “goldilocks economy” in a headline in the Financial Times for the first time since 2007.

The cover story of a permabear financial publication here in the United Kingdom screams: “The best of the bull market is yet to come. Boom Times are here again.”

Since I’m a big believer in betting against headlines, this only adds to my worry.

Then there are all of my favorite technical indicators, which show that the market is overbought, and I get even more nervous.

Such extremes in sentiment and technical signals are inevitably followed by sharp pullbacks in the market.

Low Volume, Low Volatility

Meanwhile, all of this is happening on low volume. In fact, volumes are so low that a lot of folks who trade numbers on a screen for a living at the large investment banks are on the verge of being given pick slips. There’s just not enough for them to do.

The conclusion from low volumes is more ambiguous.

On the one hand, low volumes suggest a lack of conviction. A lot of investors are sitting on the sidelines and haven’t dipped back into the market.

On the other, low volumes also signal that we are hardly at the stage of a market mania that portends a market collapse.

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As John Templeton observed, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

Judging by the low volumes, there is still plenty of skepticism out there.

And I bet you’re not getting stock tips from your shoe-shine boy.

My prediction?

I expect the market to pull back over the short term, based on its current overly euphoric sentiment.

But thanks to stimulus efforts of Mario Draghi and good economic news in the United States, the market still has plenty of upside for the second half of 2014.

In case you missed it, I encourage you to read my e-letter column from last week about five dividend-paying dandies. I also invite you to comment in the space provided below.

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