An Aging Bull Is Still a Bull

04/25/2014 9:00 am EST


James Stack

President, Stack Financial Management

Along with the emotional roller coaster, the frothy symptoms of speculation and excessive bullishness continue to build in the stock market, suggests Jim Stack, market historian and editor of InvesTech Market Analyst.

Advisory sentiment continued to show the lowest percentage of bears since 1987. Margin debt (as a percentage of GDP) hit new highs in every month of the first quarter, and just surpassed the previous peak in 2007.

And more new IPOs were launched on Wall Street than any quarter since early 2000—the final quarter of the dot-com bubble.

Margin debt is another way to monitor the degree of excesses present in an aging bull market. Speculation increases as greedy investors seek out leveraged gains, and money borrowed to buy stocks on margin can rise exponentially as a result. Peaks in margin debt usually precede or accompany the peaks in past bull markets.

While it’s too early to say where margin debt will ultimately peak in this cycle, we find it hard to envision another 18 months of parabolic rise. Once margin debt starts to decline from such lofty levels, the risk of a bear market will dramatically increase.

In spite of the above frenzied frothiness, our macroeconomic and technical evidence confirms that this is still a bull market which likely has further to run.

Overvaluation does not cause bear markets, yet no one can argue that stocks are cheap at today’s levels. Theoretically, valuations could still move higher before this market peaks.

As nervous as we might otherwise be, there’s only one way to describe breadth, bellwethers, and leadership: bullish.

Breadth is leading major indexes higher, as evidenced by the breakout in the Advance-Decline Line. As yet, there is no evidence of divergence (weakness) that has preceded prior market tops.

Bellwether stocks in sectors that peak ahead of the broader market have also moved upward to new highs recently.

So again, there is no characteristic evidence of diverging weakness from these leading sectors, which include consumer discretionary, financial, utilities, and transports.

In summary, the IPO giddiness and greed on Wall Street are making me start to feel like an outsider again. We’re turning increasingly defensive at the same time the majority on Wall Street are becoming ever more confident in their bullish outlook.

Yet, on top of these concerns is the historical fact that bull markets often extend longer than we might expect.

A bull market never dies from old age. Likewise, overvaluation, excessive bullish sentiment, and high margin debt have never triggered the end of a bull market.

Rather, they are indications, or confirmations, that the bull market is aging. And the more extreme the excesses, the greater the odds that the next bear market could turn into more than just a 20-25% correction.

Our objective is not to squeeze every last drop out of this bull market. If it were, then we would likely be closer to 90-95% invested, based on where leading economic and technical evidence lies.

Instead, our Model Portfolio is currently 82% invested, and the 18% cash reserve is not burning a hole in our pocket.

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