Overvaluation, Deteriorating Market Action, and Coordinated Exit
Historically, the best opportunities to boost market exposure emerge when a material retreat in valuations is joined by an early improvement in market action. At present, exactly the opposite is true. Extreme valuations and compressed risk-premiums have been joined by deterioration in market internals. This deterioration is an indication of growing risk-aversion among investors. Much of the recent bubble has been driven by yield-seeking, trend-sensitive speculators, with value-conscious investors progressively stepping back. As a result, any coordinated attempt by trend-sensitive market participants to exit by selling stock is unlikely to be met by demand from value-conscious investors at prices anywhere near present levels. This, in turn, leaves the market vulnerable to potentially abrupt losses.
Sizing Up the Bubble
Every financial bubble rests on the presumption that there is still some greater fool available to purchase overvalued assets, no matter how overvalued they might become. In the recent half cycle, central banks have intentionally extended this speculation by promising that they, themselves, could be relied upon to be those greater fools.