Streetwise
SATURDAY, JANUARY 21, 2012
The Dangers of Complacency
By MICHAEL SANTOLI
Investors might be getting a little too comfortable with the rally that has pushed up stocks by 4.6% already this year.
For the stock market, 2012 certainly has come in like a lamb. The major
benchmarks haven't traded in the red from the moment the ball dropped in Times
Square, the market is 20% higher than its early October low, this month's gentle
4.6% return to date is tops for any January over the past quarter-century and,
as a result, no surprise, some color has returned to the cheeks of the average
stock player.
Does this sheep-like behavior suggest that investors will soon be led to slaughter?
That's too drastic a conclusion to draw, based on the current evidence. But there are enough signs that some complacency has set in among the masses to suggest that it's wise to stay on alert for unwelcome surprises.
First, however, give credit where it's due. Exactly the sectors that a bull would want to lead the market higher have been Johnny on the spot. Home builders, semiconductors, railroads and financials have been the rabbits on the rail pacing the indexes, sending a good message about the cyclical parts of the economy. Partly, this is bounceback from late 2011 softness, but price doesn't (always) lie.
THE MARKET'S BUOYANCY suggests that the default mode has been to grind higher in the absence of the kind of nasty headlines from Europe that lead even stalwart optimists to scoop their chips off the table. And it is a net positive that the Wall Street fraternity is uncharacteristically cautious in its targets for 2012 market rewards. This should insulate the market from anything cataclysmic, as the sentiment indicators are still recovering from extreme negative readings, a pattern that tends to be equity-friendly.
Strategists' collective upside forecasts are modest and, while generally favoring stocks, the weekly Investors Intelligence Poll of newsletter writers shows exactly as many bears as there were eight weeks and 1,000 Dow points ago, a reassuring sign of stubborn nay-saying, all else being equal.
But of course, all else is rarely equal. Small investors are at least professing confidence, with the ratio of bulls to bears responding to the (admittedly jumpy and unscientific) poll by the American Association of Individual Investors at two, a toppy level. More worrisome is the fact that real-money indicators are hinting that equity investors are leaning out over their skis a bit too far for the immediate term. Short interest has shrunk severely in both exchange-traded funds and stocks. Volume in leveraged-upside ETFs versus bearish ones has reached the kind of extreme that recently has preceded market pullbacks, even as overall volume and technical momentum have been unimpressive.
Stocks have outperformed credit-market indicators, and Treasury yields have refused to relax and rise in the face of broader economic optimism. Last week featured a monthly options expiration, which for various technical reasons involving dealers' hedging patterns lent the S&P 500 a tendency to levitate to 1300-1350; it closed Friday at 1315.
THE MARKET HAS COME A LONG WAY in a little while. McMillan Analysis pointed out Friday that the Standard & Poor's 500 was three standard deviations above its 20-day average, which tends to portend at least a short, sharp reversal.
The publicity-shy investment pro known here over the past couple of years as the "mystery broker" came into the year a nervous bull, long stocks but keeping the market on a short leash as he awaited confirmation from the tape to determine if it remained a bull market. Those criteria of cyclical, risky-stock leadership, mentioned above, have checked out, yet he's tactically cautious.
For one thing, the ratio of the 15-day volume of bearish puts on the S&P 100 Index to bullish call volume hit 2-to-1 last week. Traders of these instruments, known as OEX options, are proven smart-money actors, so their caution should be heeded. In the past decade, this ratio hit this level only in February 2007, February 2011 and April 2011; it also nearly reached 2-to-1 in late October of last year.
Each instance foretold an imminent correction of some significance.
The fact that two of these episodes occurred early last year points to the similarity of that market and today's, with lots of scary macro news being defied by a quietly levitating stock market.
Of course, stocks are a bit less pricey versus earnings this year, and have endured pretty trials since then. But the notion that equities have gotten slightly ahead of themselves is as valid now as it was a year ago.
The mystery broker's verdict: He doesn't "see more than 2% to 3% upside before [a] correction."
Does this sheep-like behavior suggest that investors will soon be led to slaughter?
That's too drastic a conclusion to draw, based on the current evidence. But there are enough signs that some complacency has set in among the masses to suggest that it's wise to stay on alert for unwelcome surprises.
First, however, give credit where it's due. Exactly the sectors that a bull would want to lead the market higher have been Johnny on the spot. Home builders, semiconductors, railroads and financials have been the rabbits on the rail pacing the indexes, sending a good message about the cyclical parts of the economy. Partly, this is bounceback from late 2011 softness, but price doesn't (always) lie.
THE MARKET'S BUOYANCY suggests that the default mode has been to grind higher in the absence of the kind of nasty headlines from Europe that lead even stalwart optimists to scoop their chips off the table. And it is a net positive that the Wall Street fraternity is uncharacteristically cautious in its targets for 2012 market rewards. This should insulate the market from anything cataclysmic, as the sentiment indicators are still recovering from extreme negative readings, a pattern that tends to be equity-friendly.
Strategists' collective upside forecasts are modest and, while generally favoring stocks, the weekly Investors Intelligence Poll of newsletter writers shows exactly as many bears as there were eight weeks and 1,000 Dow points ago, a reassuring sign of stubborn nay-saying, all else being equal.
But of course, all else is rarely equal. Small investors are at least professing confidence, with the ratio of bulls to bears responding to the (admittedly jumpy and unscientific) poll by the American Association of Individual Investors at two, a toppy level. More worrisome is the fact that real-money indicators are hinting that equity investors are leaning out over their skis a bit too far for the immediate term. Short interest has shrunk severely in both exchange-traded funds and stocks. Volume in leveraged-upside ETFs versus bearish ones has reached the kind of extreme that recently has preceded market pullbacks, even as overall volume and technical momentum have been unimpressive.
Stocks have outperformed credit-market indicators, and Treasury yields have refused to relax and rise in the face of broader economic optimism. Last week featured a monthly options expiration, which for various technical reasons involving dealers' hedging patterns lent the S&P 500 a tendency to levitate to 1300-1350; it closed Friday at 1315.
THE MARKET HAS COME A LONG WAY in a little while. McMillan Analysis pointed out Friday that the Standard & Poor's 500 was three standard deviations above its 20-day average, which tends to portend at least a short, sharp reversal.
The publicity-shy investment pro known here over the past couple of years as the "mystery broker" came into the year a nervous bull, long stocks but keeping the market on a short leash as he awaited confirmation from the tape to determine if it remained a bull market. Those criteria of cyclical, risky-stock leadership, mentioned above, have checked out, yet he's tactically cautious.
For one thing, the ratio of the 15-day volume of bearish puts on the S&P 100 Index to bullish call volume hit 2-to-1 last week. Traders of these instruments, known as OEX options, are proven smart-money actors, so their caution should be heeded. In the past decade, this ratio hit this level only in February 2007, February 2011 and April 2011; it also nearly reached 2-to-1 in late October of last year.
Each instance foretold an imminent correction of some significance.
The fact that two of these episodes occurred early last year points to the similarity of that market and today's, with lots of scary macro news being defied by a quietly levitating stock market.
Of course, stocks are a bit less pricey versus earnings this year, and have endured pretty trials since then. But the notion that equities have gotten slightly ahead of themselves is as valid now as it was a year ago.
The mystery broker's verdict: He doesn't "see more than 2% to 3% upside before [a] correction."
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