By Dr. Steve Sjuggerud
For years, I’ve been extremely bullish on the stock market. And I still am, over the next year or two.
However, in the short term, one of our top indicators is giving us a big warning sign.
This indicator tells us that the stock market is getting “overly loved” by investors – and this is a bad thing.
You see, typically when a market gets “overly loved,” it often struggles to rise (at best) or even falls (at worst) over the following three months or so.
Let me explain:
“Overly loved” is not a technical term, of course. It’s a simplified way of describing investor sentiment.
If you’ve read my writings in the past, you know that I want to buy an investment when it’s hated.
(For example, you would have wanted to buy U.S real estate in 2011, when it was hated, as opposed to 2007, when it was loved.)
One of our favorite indicators for whether an asset class is hated or loved is what’s happening with the “shares outstanding” of exchange-traded funds (ETFs).
When investors get excited about an asset class, money flows into its ETFs. When a lot of money flows in, those ETFs have to create more shares. And this is where the problem enters.
“In the past few days, we’ve noted that several of the major-index ETFs have taken in their largest daily inflows of the year,” my friend Jason Goepfert of SentimenTrader.com wrote this week. That includes the funds that track the S&P 500 (SPY), the Dow Jones Industrial Average (DIA), and the Nasdaq-100 Index (QQQ).
|SPY, DIA, and QQQ all saw one-day records in the past couple of days. On Thursday, IWM [which tracks the Russell 2000 Index] nearly joined them, taking in almost $1 billion, not quite its best inflow so far this year.
Jason explained that the shares outstanding in all of these major ETFs “have seen rapid growth in the past week. The past several weeks, actually. Over the past 30 days, the funds have grown their shares outstanding by more than 13%, the second-fastest pace of the bull market.“
What does this tell us? Jason gives us the answer:
|When the funds have seen such rapid growth over a compressed period since 2010, the broader market has tended to struggle in the short term.
While the market could struggle in the near term based on this indicator, Jason normally sees this indicator as most valuable for finding market bottoms, as opposed to market peaks.
|The number of shares outstanding tends to be a better contrary indicator when there is a sharp, severe decline in shares as opposed to an increase. In other words, it’s a better gauge of excessive pessimism than optimism.
Still, it’s a warning sign that the market could struggle in the next few weeks, or even months.
I don’t think this means we’re at the end of the great bull market. I don’t think it’s time to sell everything and batten down the hatches. To me, this probably means that we’re near the end of the Trump rally- that it’s time for the Trump optimism in stocks to burn off.
Stocks will likely take a break and let all of this investor optimism wear off a bit- before the bull market resumes in full again.