Last Monday was the slowest trading session of the year, as measured by turnover in the stocks that make up the S&P 500, which in turn captures most of the give-and-take involving the stocks that matter to most investors.
The good folks at Bespoke Investment Group, at Barron's request, point out that Columbus Day is not, routinely, the sleepiest day of the year's first 10 months. By their lights, Columbus Day has, since 1993, often been an uneventful day, but never has it been the quietest day of the year to this point on the calendar.
At the risk of extrapolating too terribly much from this modest sampling of market history, the most logical explanation for the extreme "uneventfulness" of the equity market last Monday is that the bond market was closed, as it typically is on official holidays.
Stocks are now a neglected asset class, slave to the bond and currency markets. The fact that the Treasury market wasn't open for business Monday—and therefore that the largest pool of investment assets on the planet wasn't out there twitching to every hint and whisper of future central-bank action–deprived equity traders of their principal cue.
This might have marked the peak of stocks' slavish relationship with the macro forces that manifest themselves first through currency and bond markets. For months, the correlation among stocks has been so high as to mock active fund managers who attempt to pick winners and shun losers, but this all-or-nothing dynamic has faded as the market rally since early September has matured.
Not unrelated is the bounce in 10-year Treasury yields last week, from 2.38% all the way to 2.57%. The bond market is, hesitantly, transmitting the notion that even if the Fed does embark on a new asset-purchase campaign, perhaps the markets have already discounted it.
In the short term, the general neglect of equities is a headwind for the market, yet over a longer span it's a benefit. As long as stocks continue to act as nothing but the tail being wagged by the dog of the macro data driving the dollar and bonds, the less likely equities will become captive to any public mania and get overvalued and therefore vulnerable to another bruising downturn.
The folks who remain attentive to what's happening in the stock market are perhaps getting a bit too comfortable with the idea that the market can continue melting up. The weekly tally of those members of the American Association of Individual Investors who respond to the group's poll has remained above the historical average level of bullishness for six straight weeks.
That doesn't imply the best buying opportunity is at hand. And yet, the public has been a net seller of stocks for five straight months, according to the Investment Company Institute. The future returns following prior such streaks of public liquidation of equity funds have been far better than average, as BNY Convergex recently noted.
This is pretty much the salient market theme right now– investors are a bit overconfident and complacent in the very short term and yet in a broader sense are more cautious and skeptical than the economic data and market action warrant.
Here we are, halfway through October, and three-quarters of the way through the notoriously treacherous September-October period, and the much-hyped volatility storm has yet to arrive. Now that we live in a market where it's quite easy to bet on future volatility through futures on the CBOE Volatility Index (VIX), traders have bid up expectations of impending jumpiness to an alarming degree.
Often this has proved a harbinger of tumult to come, but given how widely anticipated the unsettled market weather is, perhaps we're inoculated from its nastiest implications.
On some level the market is simply reflecting the less-reported signs of healing in the economy. Retail sales just re-attained the level right before Lehman Brothers' failure. Nominal gross domestic product is at a record high. Mergers and acquisitions look poised to accelerate. The market has held up despite the stark underperformance of financial stocks, just as it did in 2004 in the face of stagnant semiconductor stocks (then considered a bellwether).
It's not a novel thought to offer that stocks seem ripe to pull back or at least flatten out for a bit. Whatever the salutary effects of a Republican rout on Nov. 2, they seem already more than discounted. Yet there's enough skepticism there, that any stiff pullback would likely be a reason to buy, and not to panic.
Mr. Santoli was interviewed on Yahoo Tech Ticker (see video below) stating that bulls were "caught offside" by China Rate Hike, BofA Woes:
Stocks slumped Tuesday following a surprise rate hike by China's central bank and a "sell-the-news" reaction to earnings from tech giants IBM and Apple. The selloff picked up steam mid-afternoon on reports Pimco, Blackrock and the NY Fed want Bank of America to repurchase $47 billion of mortgage-backed securities they claim were improperly serviced by its Countrywide unit.
"This is the tip of the iceberg," writes market-timer Thomas Kee, president and CEO of Stock Traders Daily. "This is the beginning of [sic] PUT BACKS. It will be a long legal haul, and another added weight on banks."
Even excluding the latest worry about financials, several factors conspired to drag stocks down Tuesday, Barron's columnist Mike Santoli tells Dan Gross and I in the accompanying clip.
After a 12% rally in the past six weeks, the market was technically overbought and the short dollar/long financial assets trade had become "very crowded," Santoli says. "A lot of people were caught offside" by China's rate hike and irrationally exuberant about prospects for more quantitative easing by the Fed. (Indeed, commodities and other "risk assets" joined stocks in retreat Tuesday as the dollar posted its biggest one-day rally since August.)
A Headwind for the Market
These "hair-trigger moves" are contributing to investors' mistrust of the market, Santoli says, as evinced by the steady outflows from equity mutual funds - despite the market's strength prior to Tuesday's tumble.
"There's definitely been a context shift" since the ‘Flash Crash' in May, he says. "It's not as if people are panicking out of stocks. They're steadily selling [and] diversifying out of stocks. It's going to be a headwind for the market for a while."
Despite their short-term bullishness, professional investors also have an eye on the exits, Santoli says, noting a "steady bid" for futures predicting a rise in volatility over the next six months. Investors have a "muscle memory" of 2008 and think "something could upend the market anytime." (Something like, say, an unexpected rate hike by China.)
But if sentiment is really a contrarian indicator, this underlying skepticism "tells me this is not a market that's getting overheated or a market that's going to a valuation extreme," Santoli says, building on the theme from his most- recent column: The Storm that Wasn't.
My take on today's action? It's just another day in the wolf market where the wolves were busy stealing shares from retail suckers and institutions that dumped because they panicked/ cut risk. Nothing has changed. The mortgage mess isn't going to kill banks, and smart money is still betting on the Bernanke put.
Importantly, top hedge funds are using these pullbacks to build on their positions, especially in energy and commodities. And what about pension funds? Some, like the Caisse, are prepping for the next big move, and mark my words, the next leg up is going to be huge. A lot of asset managers are underperforming their indexes, so they'll use any pullback to juice their portfolio with high beta stocks.
Speaking of high beta stocks, my beloved Chinese solar stocks got killed today, led by my number one pick, LDK Solar (LDK), down 14% on very high volume. In fact, volume was extremely high in the solar sector today, telling me that the wolves were up to their crooked ways, naked short selling and buying more shares on the cheap.
Watch this and other sectors very closely and use these pullbacks to accumulate more shares. As more Fed officials come out to state that quantitative easing has to be big, all the makings for a massive bubble are on their way. My big bet remains with alternative energy but others prefer gold, commodities and energy. It doesn't really matter, because all I know is that once the bubble sectors take off, they're not coming back to these levels. That much I can guarantee you.