4 Reasons the Nasdaq 5K Won’t Last

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nasdaq - 4 Reasons the Nasdaq 5K Won’t Last

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To great fanfare, the Nasdaq Composite closed above the 5,000 mark on Monday — returning to levels not seen since 2000 at the height of the dot-com boom.

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And while the Nasdaq was not able to hold the 5,000 mark on Tuesday, the financial media echo chamber is reverberating with calls about how this time is different and how the gains are set to stick.

Maybe so.

But in the short term, stocks are looking ready for a violent pullback. Investors looking ready to pile into stocks at these heights would do well to be patient, wait for the fever to break and for a buying opportunity to appear.

Here are four reasons why.

4 Reasons the Nasdaq 5K Won’t Last: Dow Theory

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 Developed in the late 1800s by Charles Dow (part-owner and editor of The Wall Street Journal), the Dow Theory suggests that in order to declare a move in the Dow Jones Industrial Average as a true trend it must be confirmed by the transportation and utility averages.

That’s not happening now, as shown in the chart at the right. While the industrials pushed to a new record high, transportation and utility stocks are not playing along.

Similar divergences were seen back in July and in September ahead of major broad market swoons.

4 Reasons the Nasdaq 5K Won’t Last: Breadth

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 While stocks have marched to new record highs, it’s done so on the back of a narrowing group of stocks — a sign of declining buying interest at these prices, a sign of potential weakness.

You can see this in the chart, showing that just 75% of the stocks in the S&P 500 are in uptrends — a limit that has been in play since August, compared to a high of 85% back when stocks peaked in July.

Consider that during Monday’s record-setting session, stocks had the fewest quotes in six months (excluding holidays) while there were only 648 net advancing issues on the NYSE, compared to a peak of 2,500 when stocks surged out of the October low.

4 Reasons the Nasdaq 5K Won’t Last: Fundamentals

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 Let’s just be honest: Stocks are being powered higher almost exclusively by hopes, dreams, and multiple expansion.

The hard data, on both forward earnings and the U.S. economy, rolled over months ago. As seen on the chart, equities diverged from the data and ramped higher after stocks suffered their mid-October dip.

The cause célèbre has been the promise of cheap money stimulus from the major central banks. Back in October, it was all about hints the Federal Reserve could restart its bond-buying program if the economy falters.

More recently, it’s been about stimulus moves by the European Central Bank and the People’s Bank of China.

4 Reasons the Nasdaq 5K Won’t Last: Sentiment

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 Despite the ebullience shown in the Nasdaq, stocks have separated wildly from the fundamentals with both earnings and macroeconomic surprises rolling over. It’s an open question how long sentiment alone — via multiple expansion — can keep pushing stocks higher in this environment.

The melting away of worry can be seen in the way the CBOE Volatility Index — known as Wall Street’s “fear gauge” — has collapsed since late January.

For example, options traders have jumped into bullish strategies and neglected bearish ones to one of the largest degrees since 2000 and has reached a level that’s only been exceeded twice before.

Yet Wall Street pros and corporate insiders are stepping away. According to data from SentimentTrader, “smart money” traders are bailing out of this market at current levels — based on things like commercial equity hedging in the futures market — amid rapid multiple expansion and severe technical overbought signals. For tech insiders, negativity has reached a five-year high based on data from InsiderScore.

But “dumb” money traders — measured by things like small speculative positions in equity futures — are bulled up in a way that hasn’t been seen since 2004.

How to Play the Nasdaq 5K

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 I continue to recommend clients look for pockets of opportunity, such as renewed weakness in crude oil. The Proshares UltraShort Crude Oil (NYSEARCA:SCO) recommended to Edge subscribers is up nearly 8% since Feb. 18, while the Mar $18 puts against the United States Oil Fund LP (ETF) (NYSEARCA:USO) recommended to Edge Pro subscribers were trimmed last week for a 65% gain.

I think the best opportunity at the moment is going long volatility, and have recommended the Mar $28 calls on the iPath S&P 500 VIX Short Term Futures TM ENT (NYSEARCA:VXX).

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.

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