"It’s essential to monitor the uniformity of market internals, because investors still have the speculative bit in their teeth. The problem is that this has also often been true at the very peak of ‘V’ tops like 1929 and 1987. That’s why sufficiently overextended conditions can hold us to a neutral stance even in some periods when our measures of market internals are constructive. An increase in divergence or general weakness across individual stocks, industries, sectors, or security-types (including debt securities of varying creditworthiness) would shift market conditions to a combination of extreme valuations and unfavorable internals, and open up the sort of ‘trap door’ situation that we observed in March."
– John P. Hussman Ph.D., December 20, 2020

The speculative “V” is one of the most interesting and challenging features of the market cycle. For passive investors, it can be a period of exhilaration followed by panic. For historically-informed, value-conscious investors, it’s typically a period of annoyance, bordering on contempt, for what Galbraith called “the extreme brevity of the financial memory” – often followed by opportunity and even vindication. Still, the collapse of a speculative bubble can be curiously unsatisfying (as it was for me during the 2000-2002 and 2007-2009 collapses) if one happens to care about the well-being of others.

As I’ve often discussed, the only aspect of the recent speculative bubble that was truly “different” from other market cycles across history was this: even extreme syndromes of “overvalued, overbought, overbullish” market conditions failed to signal a reliable “limit” to speculation. In late-2017, I abandoned my bearish response to those syndromes, along with my belief that reliable “limits” to the recklessness of Wall Street still exist. But as we saw as recently as March, the market can still suffer significant losses during periods of risk-aversion, when the speculative bit drops out of investors’ teeth.

Market cycles haven’t ceased to exist. It’s just that historically reliable “limits” haven’t been effective in recent years. So we’ve become content to gauge the presence of speculation or risk-aversion, without immediately becoming bearish once speculation has become outrageous. While sufficiently extreme conditions can still hold us to a neutral market outlook, the shift to a bearish outlook requires deterioration or divergence in our measures of market internals, which are our most reliable gauge of whether investor psychology is inclined toward speculation or toward risk-aversion.

A week ago, our primary measures of market internals shifted to a negative condition. That shift was a bit surprising, because it was driven by components that capture market behavior across “debt securities of varying creditworthiness.” Interestingly, those debt-sensitive components were also the first to shift negative at the 1987 and 1929 peaks. The equity components shifted later. I often describe unfavorable shifts in market internals as being driven by “deterioration” and “divergence.” In 1987 and 1929, the ascent to the bull market peak was so steep and indiscriminate that there was little “divergence” in the equity components at the highs. Instead, the equity components shifted only after a sharp, near-vertical initial loss.