Melt Up or Fakeout

We are now at the highs of the year, busting through the high set on April 20.  Oil is above $50.  Yet 10 yr bond yields are stuck close to the lows for the year, at 1.72%.  I know that all else being equal, lower bond yields are better for the stock market.  But all else is not equal.  The economy has been getting weaker, and finally with a bad jobs number, the public is realizing it.  It is almost as if a weak economy is good for the stock market because then the Fed won't raise rates.  But this market forgets that a weak economy hurts earnings, which is way more important than a 25 bps hike in the Fed funds rate.

From what I am hearing on CNBC and Twitter, many are looking for more upside and a possible melt up.  I would agree with that view if the market kept going higher last week and didn't trade between 2085 and 2100 for so many days.  Usually up moves that will last for months don't stop and pause for several days to catch their breath after going up for just 1 week off the bottom.  

Just look at what happened in late November/early December 2015 in the SPX to see an example of why breaking out from a recent tight range (after a big rally) doesn't always mean a continuation of the move.  You had a false breakout of a tight range on December 1, and then went immediately lower.  In December, you got a lot of chop, dips that were immediately bought, and then 3 days of rally that were immediately sold, repeated a couple of times, to eventually setup a waterfall decline the next month.  

I don't want to rely too much on recent trading patterns as the main reason for my pessimism, but it adds an extra bit of information when forming a market view.  I am mainly going to look at fundamentals and daily market data such as earnings trends, valuations, investor money flows, put/call ratios, and commercial/speculator positioning.  

The majority of what I am looking at is pointing to weakness in the coming months.  Now that we have finally got rid of the bearish sentiment and complacency is here again, the market will have a hard time blasting higher with these weak fundamentals.  Fundamentals are the long term driver of markets, not sentiment.  Sentiment is useful to predict short term bottoms and a topping process, but not long term trends.  

It is always harder to pick a top than a bottom because the tops usually last longer and are a process rather than an event.  But if you are going to get bearish, this is about as good a risk/reward that I have seen this year.

Yesterday was the first time you really saw a very low put/call ratio for both the equity and index options.  Previously, most of the call volume was focused on equity options.  The market is getting too hot with speculation of further moves higher.  It seems like a combination of some residual short liquidations and FOMO for the underinvested.  Those drivers usually do not last for long.

I did get short S&P on Friday and was too early and got stopped out at 2115.  I see that we are already fading from that level.  I will look to get back into the short either today or tomorrow and hold on with a stop above the all time highs at 2035(edit 2135), with a target of 2060.