Are We Close To A Top? Here’s What I Think…
Despite a few down days in the first few months of 2021, stocks have continued to grind higher. Many analysts have started to consider whether we’re getting close to a top.
And I’ll talk more about that in a little bit, but first I want to take a look at how markets top.
The most important thing I want to point out to you is that there is almost always a bounce. It may not be quite as high as the top before the drop, but it’s certainly better than the bottom. In other words, it doesn’t make sense to panic when the first big drop occurs because there is usually a second chance to get out. That can be seen in the chart of the Dow Jones Industrial Average in 1907.
We also see a second chance to sell in 1929.
And, again in 1987.
The next example, the Dow in 2000 could be considered the exception that proves the rule. While we do see a slight bounce after the initial drop, it is significantly below the top and would be a disappointing “second chance” level.
The rule of second chances works again before the 2008 bear market.
Okay, that’s enough history. Let’s jump back to what’s going on today.
Can The Good Times Roll On?
Once again, the Dow is sitting pretty at all-time highs, which we can see in the chart below. There’s a big drop right in the middle of the chart that occurred when the COVID-19 pandemic hit and the world went into lockdown. Prior to that drop, the Dow had also been creating new all-time highs.
This chart shows that a pullback is always possible — even when the market looks strong and is creating new all-time highs. However, I don’t believe this top necessarily means we’re “due” for a bear market. In fact, my analysis shows the start of the next bear market could be several weeks or even months away.
Several factors support a bullish outlook. One is the Federal Reserve. As I have discussed for several weeks, the Fed has set interest rates at historic lows and assured investors that rates will remain low for some time. In addition, the Fed is adding money to the economy at an unprecedented rate. This is shown in the next chart.
Source: Federal Reserve
This is a chart of the growth in M2, a broad measure of money supply. It shows the year-over-year growth is at new highs and still growing.
Another reason to be bullish is earnings growth. According to a research report from FactSet released last week, there was a “record-high increase in S&P 500 earnings per share (EPS) estimates for the first quarter.” This shows analysts are becoming increasingly optimistic.
Companies will begin announcing earnings for the first quarter in the next few weeks. Analysts expect EPS growth of 23.8%. In the second quarter, growth is expected to accelerate to 52.5% and come in at 25.9% for the full year.
For 2021, EPS for the companies in the S&P 500 are expected to reach $175.75, topping the previous record of $163.12 reached in 2019. In 2022, EPS are expected to top $202.
With rapid earnings growth, a higher-than-average valuation is justified, and that could explain why stock prices keep going up.
What My Indicators Say
On the next chart, you can see SPDR S&P 500 ETF (NYSE: SPY) with my Income Trader Volatility (ITV) indicator in the bottom panel. ITV (red line) crossed below its moving average (blue line) last week. ITV is similar to VIX in that it rises as prices fall. If ITV remains below its MA, additional gains are likely.
Our last chart this week shows the daily chart of SPY with my Profit Amplifier Momentum (PAM) indicator in the bottom panel. This indicator, which was designed to be a short-term indicator measuring market volatility, is also bullish. This confirms the other bullish evidence we’re seeing.
Action To Take
My indicators are bullish. Earnings and money supply are bullish. Plus, history says that the bear market is unlikely to start from all-time highs.
That’s a lot of factors in favor of a bullish market right now. As for me and my followers, we’ll follow where the evidence leads and remain bullish — but also cautious.
I’m not interested in getting caught up with irrational enthusiasm in this market. I’m not going to chase trades in hopes of making big-time gains, either. Instead, I’ll stick to my time-tested strategies that work in any market and pay my readers and me with immediate income — week in, week out.
Best of all, one of the strategies I use works like an “insurance” policy — protecting us, while still giving us the chance to profit.