Topping Process In Motion

The global equity indexes are too high.  They can only sustain high levels if interest rates stay low.  It is all one big connected market place.  You cannot ignore the bond market if you want to predict the stock market.  Since risk parity strategies are en vogue on Wall Street, it seems appropriate that you get the topping process started with bond weakness leading stocks lower.

Just like Tuesday, when bonds and stocks both fell hard, we have the same situation again today.  Yesterday was the day that dip buyers came roaring in, like salivating hound dogs buying up everything.  Now that those eager buyers are out of the way, We get back to selling.  These are the kind of moves that are the hallmarks of a topping process.  It is hard to call the top, but it's not so hard to identify the topping process:

1. Usually you get a flattening out of the uptrend and increased day to day, week to week volatility.  Definitely happening this week.
2. More speculative, high beta stocks are in favor.  A few weeks ago it was the Nasdaq 100 stocks.  More recently it has been biotech.
3. Breadth narrows as the fundamentals worsen, leading investors to pile into the few stocks that still have good growth and fundamentals.
4. Put/call ratios get low, and stay low.  That has definitely been happening this month.
5. Bullish sentiment has topped out.  This is the tricky part.  Contrary to what most contrarians think, investor sentiment usually tops out before the stock indexes do.  This can be rationalized by the breadth measures.  If most stocks in a portfolio start going down, while the index remains higher, naturally the mood will sour a bit.  This also happened, as there was a lot of bullish sentiment at the end of last year and early this year due to Trump trade, and more recently, with Macron winning the French elections.

This topping process can last several months, like 2015, or be briefer, like 2007.  3 to 6 months seems to be the average length.  If the topping process has started this month, that means that we will form a big top this year and enter much weaker markets in 2018.  That aligns with my long term view of the market.

There is still time to wait for a good entry to short, preferably on a rally back towards all time highs.  But for those active traders, it is now a much more favorable market to short rallies, with a high probability of a dip within a week.  Equities feel saturated now.  And the central banks are not looking to help right away.  A big difference from the 2010, 2011, and 2015 tops.