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These charts help us understand that a top is not just price, but a reversal in extremes of margin debt, valuation and sentiment.
In blow-off tops, extremes of valuation, complacency and margin debt can always shoot beyond previous extremes to new extremes. This is why guessing when the blow-off top implodes is so hazardous: extreme can always get more extreme.
At tops, soaring margin debt no longer pushes stocks higher. I’ve marked up an excellent chart by Doug Short to highlight the diminishing returns of more margin debt at tops.
It’s clear this same dynamic of diminishing returns is in play now, as margin debt has skyrocketed while the S&P 500 has remained range-bound, with each new high being increasingly marginal.
It appears that the Shenzhen bubble has burst. Latecomers to the bubble party will continue to buy the dips, but the ADX (a measure of trend strength) has been diverging for quite some time, and the MACD is rolling over into a sell signal.
These charts help us understand that a top is not just price, but a reversal in extremes of margin debt, valuation and sentiment. Many observers have an unyielding faith that central banks will never let markets decline ever again. There are four flaws in this blind faith:
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