It sure is great that NASDAQ has managed to close well over the 4800 level so solidly, even within striking distance of the 4900 level. The November and December peaks and the December and January dips now seem so safely behind us. Looks can of course be deceiving. The big question is how much longer can we expect this advance from the dip to 4600 at the beginning of February, just two weeks ago, to last? Unfortunately, history says that anything can happen at this stage.
Sometimes NASDAQ will solidly hit a new peak and then just completely fall apart. Why? Typically because a lot of the rise was due to the forced buying of short covering, and then as soon as the buying pressure peters out, the shorts come back with a vengeance. We saw this for the November and December peaks.
Sometimes the new peak will persist for a few days. Why? Same as before, but sometimes it can take a few days for the dust to settle before a critical mass of the shorts feel it is safe for them again.
Sometimes NASDAQ will in fact build one or more new legs on the new peak before running out of steam again in a few weeks. We saw this in November, where NASDAQ topped the September peak at the end of October and then added another 150 points over a month. That was a nice, sweet run. Yeah, although it ended badly with a 250-point plunge to the December trough.
And sometimes, NASDAQ actually can have an extended run-up, as we saw a few times in 2013, such as the run from early September through early December, three months, with no dips of more than 25 points. That's a rarity, but it does happen, and that was less than 18 months ago.
There are a number of key points to consider, some on the plus side, and some on the minus side. On the minus side:
1. Stocks are a lot closer to being fully or over-valued compared to 18 months ago.
2. Some fraction of market participants worry about looming Fed rate hikes later this year.
3. Geopolitical risks, including sluggish Europe may drag down multinationals despite strength in the U.S.
4. Boomers creeping towards retirement will be shifting assets from stocks to bonds or cash.
5. Hedge funds seeking to boost their skimpy returns are resorting to short-term trading of stocks, on both the long and short side, increasing volatility and favoring swings rather than straight-line moves.
6. The specific economic and business outlook has a lot of uncertainty.
On the plus side:
1. The U.S. economy is picking up steam, albeit unevenly, and is significantly stronger than 18 months ago.
2. A growing economy means more money flowing into retirement accounts and pension funds, and from there into mutual funds and stocks.
3. Anxiety over low interest rates on bonds pushes money into stocks.
4. Hedge funds have a lot of heavy short positions in place, so even a moderate improvement in the economy could fuel a fair amount of forced buying to cover those short positions.
5. On any renewed strength in stocks, more hedge funds could shift to a stronger risk-on bias and shift from shorting stocks to going long.
Those were not meant to be exhaustive lists.
There is no simple (or complex) equation to net all of those factors into a single number. Worse, all of those factors are constantly evolving, so that the net effect is extreme volatility.
That extreme volatility does mean that the market can turn on a dime with significant frequency, as we saw with the multiple dips and peaks in January. The good news is that even with volatility, as with completely random events such as flipping a coin, sometimes you can indeed see a whole string of volatile moves that all move in the same direction, just like a string of heads for a flipped coin. That doesn't happen frequently enough to bet the farm on it, but often enough that we need to be prepared for it. Good news can be a black swan event as well as bad news.
In summary, this latest NASDAQ advance could last a day, a week, or a month with probably equal probability. Or maybe even Friday was the end of the advance. Or maybe we have two or three weeks to go. None of these outcomes would be a shock or surprise to me.
And along the way, dips of 25 to 100 points are to be expected for any advance. Typically an advance is made from a number of legs, with modest to moderate dips between them, before we finally see an actual correction of 10%, or even what I call a mini correction of 5% (3% to 7%.)
I do strongly suspect that the advance will last a bit longer, and I am personally betting on it to some extent, but don't hold me to that! And meanwhile I keep enough reserves to capitalize on any big dips of solid stocks, or the overall market for that matter.