Investor sentiment has reached levels of euphoria and greed that exceed the excessive optimism at the stock market top in 2000, says Robert Colby, Chief Investment Strategist at Robert W. Colby Asset Management.
Colby says the US stock market is overbought and overvalued relative to traditional measures: earnings, dividend yields, and book value, and that “stocks are priced for an extremely optimistic future, ignoring all potential bumps in the inherently unpredictable road ahead.”
He points out that a small subset of well-informed investors are selling stocks like never before. Corporate insiders, including officers, directors, and very large investors, are selling nearly 8 times more stock than they are buying, which is a far above the previous record (Chart 1).
While the $VIX Volatility Index, currently at 21.58, is relatively low compared to its March peak above 80, it is still high compared to its 10-year average of 17.56. Colby points out that times of rising volatility coincide with falling stock prices and, given the risks, he thinks volatility could easily jump up again.
Focusing on the S&P 500, Colby notes the RSI, MACD, and Stochastic short-term oscillators remained below their September peaks despite the rise in prices, indicating that price momentum has been slowing. Moreover, the Percentage of S&P 500 stocks that are above their own 50-day moving average fell to its lowest level since early November, despite the increase in the price index (Chart 2). Weakness in this popular breadth momentum indicator is further evidence that the market’s uptrend is losing power.
As such, Colby wants to be ready for anything and is thinking in terms of capital preservation. He says to look out for bearish divergences between the index and the oscillators, which can provide an early warning of potential trend change.