Friday, January 6, 2017

A Bubble Can Happen

It is hard to predict bubbles, because they occur when human nature goes from being scared to participate to fear missing out.  The huge inflows since Trump became elected clearly shows a transition taking place. From being scared of buying equities, which betrayed them in 2000-2002 and 2007-2008, to the fear of missing out, after 7 straight years of gains (with dividends included).

Although my base case is for the market to top out in the spring, near 2400, there is always a probability that the market overshoots and enters into a bubble, like you overshot in 2000 and 2007.  I would say there is a 30% chance that we top out between 2280-2350, about a 50% chance of topping out between 2350 and 2400, and a 20% chance of the market entering a full blown bubble and topping out above 2400.

The funny thing is that those who are looking for a correction and are bearish now, at 2275, will be eager to buy if we get to 2350 and then fall back down to 2275 later this year.  That is just human nature reluctant to buy all time highs.

It doesn't take a great imagination for investors to get all bulled up as Trump delivers on the big tax cuts and deregulation, and does almost nothing meaningful on trade.  That would be the most likely case.  The infrastructure is meaningless, because the implementation is so slow, and always done on too small of a scale.  All this stock market cares about is those huge tax cuts.  Once the tax cut bill starts taking shape and is announced, the enthusiasm will probably be much greater than what you see now, with a probable higher price tag on the S&P 500.

The animal spirits this year cannot be underestimated, especially considering the amount of bearishness you had for so long from August 2015 to June 2016 (Brexit).  It takes time for the public to fully embrace the stock market again after that long period of bearishness.  Usually at least a year from the scary period.   If we didn't get a purge like we did early last year, I would be much less confident about the market rising in early 2017.  The trick is to figure out the best way to play the rise and fall in 2017.  I am going to be conservative and wait for a good time to short, and not try to ride the final wave higher, although I am fairly sure that we still have higher to go.

If I do play long, it would be for just swing trades, nothing long term.  But I have a feeling that this market will not be providing any easy long entries as we head towards the top.  Usually the final move higher in a bull market happens without a pullback along the way.  Picking a top right now is downright dangerous, so I will wait for more Trumponomics "certainty" before I short.

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