Is the Mix of QE and Fiscal Chaos the Perfect Environment for Stocks?

iSPYETF

Chaos is rarely a good thing. Most of us try to avoid chaos at all cost, but the financial chaos caused by the debt ceiling drama may be the best thing to happen to stocks since QE. In fact, political chaos makes QE even more powerful.

I know this is a bold statement, allow me to explain why the embarrassing deficit ceiling brinkmanship may have extended the lifespan if this bull market.

It’s often said that bull markets climb a ‘wall of worry’ (by now you probably know where I’m going with this).

Bull markets need suspicious und unconvinced investors stuck on the sidelines. As prices grind higher, suspicious investors turn into buyers and provide the fuel needed to ‘burn’ higher.

How Much ‘Gas is Left in the Tank?’

Is there enough ‘gas left’ to drive stocks higher? In other words, are there still enough investors that haven’t bought into the rally yet?

It seems like it. I follow literally dozens of sentiment and money flow gauges to get a comprehensive read on investor sentiment. 

This is not the place to list all of them, but the two gauges shown below are a good enough proxy of current investor sentiment.

The chart below plots the S&P 500 (^GSPC) against the percentage of bullish investment advisors and newsletter writing colleagues polled by Investors Intelligence (II) and the percentage of bullish investors polled by AAII.

View enlarged S&P 500 / Sentiment chart here

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The vertical red lines on the S&P 500 chart mark recent S&P 500 (SPY) tops. The horizontal lines show where sentiment was compared to today.

Individual investors polled by AAII are more bullish than bearish, but not to an extreme. Investment advisors polled by II view the current rally with suspicion.

When looking at the II data, we should keep in mind that the results were published Wednesday morning before Washington announced a tentative deal on the debt ceiling. There may be a spike in bullishness with next week's poll.

Historically Suspicious

Nevertheless, sentiment would have to soar quite a bit to match prior peak readings. 

The S&P 500 and large caps (IWB) are trading about 20% higher compared to its 2012 top, but investment advisors are 20% less bullish today than in May 2012. Additionally, the Nasdaq-100 (QQQ) has soared to a 13-year high.

One could almost think that the Federal Reserve and Washington are working together to manufacture the perfect environment for rising stocks.

The Federal Reserve created the most hated rally in the world (decent humans take offense to the idea of a rigged market) and Washington provides the kind of instability and inability needed for a ‘wall of worry.’

Technical Confirmation

Technical analysis highly suggested a rally to new highs over two weeks ago. The October 7 Profit Radar Report stated that: “The scenario that appears to make most sense is a quick trip into the 1,660s or 1,650s followed by another rally to new all-time highs.”

Two days later, the S&P 500 briefly dipped to 1,646 and rallied strongly thereafter.

In an October 11 article I asked: “Has the Year-end Rally Already Started?” The introductory comment read as follows: “The S&P 500 just started a pattern that led to extended rallies and new highs in 2012 and 2013.”

The article explained the details of the bullish technical pattern along with the initial up side target for the S&P 500 and Nasdaq. The full article is available here:

Has the Year-end Rally Already Started?

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF 

 



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