It has been four months since the S&P 500 suffered a daily loss of at least 1 per cent, the longest streak since 2006. With stocks hitting fresh all-time highs, is a pullback overdue?
Larry Fink, chief executive at BlackRock, the world's largest asset manager, warned last week that he saw "a lot of dark shadows", but sentiment indicators suggest markets are not positioned for any unpleasant surprises.
An Investors’ Intelligence poll of newsletter writers shows optimism has been at extreme levels for three consecutive weeks, with bullishness now at its highest level since 2005. Bearishness is at its lowest since August 2015, just before markets suffered their first double-digit correction in almost four years.
The Vix, or fear index, last week fell below 10 for the first time in a decade, suggesting potential complacency. In fact, BCA Research’s Complacency-Anxiety Indicator (CAI), a tool using many variables to gauge investor positioning and sentiment, is at its highest-ever level, signalling “extreme confidence”. The consensus “is focused solely on return rather than risk”, which suggests “maintaining a capital preservation mindset, rather than chasing market euphoria in the near run”.
No one rings a bell when the market peaks but sentiment data suggests markets are, as Fink cautions, “probably ahead of themselves”.
Klarman concern over ‘unpredictable’ Trump
Elevated sentiment may be a red flag, but pullbacks generally require a catalyst. What could trigger a retreat? The obvious possibility is that markets begin to focus on the level of uncertainty that’s out there.
The Global Economic Policy Uncertainty Index hit record levels in November, while January's reading was the third highest on record. Elections in France, the Netherlands and Germany have the potential to add to that uncertainty.
Perhaps the obvious source of uncertainty, of course, is the man in the Oval Office. Markets are enthusiastic about tax cuts which may not take place until 2018, says BlackRock’s Larry Fink, but Donald Trump-induced trade disruptions are a possibility in 2017.
That's echoed by legendary value investor Seth Klarman. In his annual letter, Klarman, a Warren Buffett-like figure who has lost money in just three of the last 34 years, warns markets are focused on tax cuts while largely ignoring protectionist risks. Concerned by "perilously high valuations", he is fearful of the prospect of rising deficits, rising rates and rising inflation.
Above all, Klarman, who has donated to Republican politicians in the past, is concerned about Trump. The “indulgent” tweeting, the “erratic tendencies and overconfidence”, the “shockingly unpredictable” behaviour: the “big picture for investors”, says Klarman, is that “Trump is high volatility”.
Investors “generally abhor volatility and shun uncertainty”; any missteps could yet trigger “global angst”.
Buy the dips?
Nevertheless, history suggests any near-term weakness is unlikely to be sustained. Markets registered positive year-to-date readings on every day in January, notes LPL Research, not suffering a single daily decline of 1 per cent. Such calm is rare, happening on just six occasions since 1950. Markets advanced in all six years, averaging gains of 15.4 per cent.
A fluke? Perhaps, but it may reflect the fact that it rarely pays to bet against bull markets. The current rally might be especially fragile if it were solely built upon Trumponomics, but that's not actually the case. Nobel economist Paul Krugman last week admitted he was "not as sure as I was that there's a huge Trump bubble buoying markets".
Yes, stocks have enjoyed post-election gains, but they are not that large compared to past fluctuations. Real interest rates and inflation expectations have risen, but that may reflect an economy nearing full employment as much as Trumpmania. Markets “haven’t moved nearly as much as the hype suggests”, says Krugman.
Goldman Sachs data confirms this thesis. In a recent note examining correlations between dozens of assets and bond yields, Goldman found most of the post-election trends were already in place prior to the election. Those same trends should “slowly continue”.
In short, the bulls remain firmly in charge, suggesting dips will be short-lived affairs.
Snapchat hype excites dumb money
There’s growing hype surrounding the forthcoming initial public offering of Snap, the maker of photo app Snapchat, and it seems some investors just can’t wait. Shares in Snap Interactive, an unrelated microcap stock, soared more than 160 per cent over a four-day period last week.
This isn’t the first case of mistaken identity. Indeed, Stocktake has previously pointed out you could make some nice money by anticipating a flood of dumb money into sound-alike stocks. Penny stock Nestor soared 1,900 per cent after Google’s $3.2 billion (€3 billion) acquisition of Nest Labs; bankrupt penny stock Tweeter Home Entertainment surged 2,000 per cent after being confused for Twitter; Canadian firm Oculus Vision Tech rose more than 150 per cent after Facebook’s $2 billion purchase of Oculus Rift.
To borrow from HL Mencken, no one ever went broke underestimating the intelligence of investors.
