Early this week, the VIX “fear index” was at its lowest level since 2006. Big-time buyouts were making waves on Wall Street, and the Dow Jones and S&P 500 were up against new all-time highs.
Everything was grand … until the Federal Reserve signaled it may wind down its quantitative easing policies faster than expected. The result was a triple-digit sell-off for the Dow, marking the second-worst trading day of 2013.
Now, financial media is aflutter with talk of continued declines. And the talking heads are right to do so.
Unfortunately, they are not “right” because of the Fed. They are also not “right” because of softness in consumer spending or disappointing housing data this week, either. The fact is the pullback we are assuredly entering is structural, and not based on news.
The fact remains that even the long-term bulls were looking for a short-term dip after the strong rally to start the year, lest stock valuations get ahead of themselves.
Beyond the churn of the headlines, here are some bigger reasons this market decline will keep going — and will ultimately be a good thing for the market’s long-term recovery:
Newsletter Craze: As technical analyst J.C. Parets of All Star Charts points out, newsletter writers are recommending record exposure to equities. The last time they were this bullish? Late 2007 and early 2008. Oops. But that doesn’t mean that J.C. is a bear — rather, he says “I have more buying to do anyway. Let’s correct already and be done with it. The suspense is killing me.”
Options Activity: Surly Trader over at Pragmatic Capitalism has a great post on the Credit Suisse “Fear Barometer” of options activity. Check out the full post for details, but in a nutshell the measure is near an all-time high thanks to low demand from call buyers, a high supply of call sellers and high demand for protective puts.
Good-News Drought: Kicking off the first day of trading this week, Paul Vigna over at the WSJ MarketBeat blog said it best: “Unless something pops up from unexpected corners, it’s hard to see what’s going to give traders much momentum this week. There’s nothing top-tier — a couple of housing readings, producer and consumer prices for January, weekly jobless claims — on the data calendar.” With most of earnings behind us and little to look forward to beyond the ugly sequester fight, there don’t seem to be many headlines that could move the market higher. Next week also looks rather ho-hum, with a Q4 GDP update and some good consumer data … but it seems unlikely either will come in tremendously positive.
Who’s Still Out?: Ari Wald of PrinceRidge pointed out last week what should be obvious after the Apple (NASDAQ:AAPL) meltdown: When buyers have already bought in, that’s when momentum wanes and sentiment swings the other way. In his words, “When fewer longs are left to propel stocks higher, the market’s rate of ascent subsequently declines and price will generally level off. Then as supply and demand come into balance, a small disturbance can be intensified by a negative feedback loop and initiate this circuit in the opposite direction.” In other words, few buyers mean little upside and big downside risk. (Hat tip to Josh Brown of The Reformed Broker for sharing.)
Complacency Creep: Adam Shell of USA Today posted a feature recently with a nifty graphic that details declining volatility in the market. But buried in this piece there is a good quote from Bob Doll, chief equity strategist at Nuveen Asset Management, in regards to relative market stability: “That does not mean some short-term complacency hasn’t crept into the market. It probably has.” Complacency is not optimism.
Outright Pessimism: This Reuters article takes that previous statement one step further with two quotes from Wall Streeters that are telling. Bruce Zaro of Delta Global Asset Management said “I do suspect the closing of the earnings season will lead to at least a pause and possibly a pullback [of 3-5%].” Separately, Dave Chojnacki of Street One Financial said “We just don’t have the volume or the catalyst right now” to break through upside resistance. These two guys are clearly much more than just complacent.
Consolidation is Natural: Blogger Dynamic Hedge is representative of many market watchers out there. He remains long-term bullish and thinks we have yet to see the high point of the market in 2013 … but is quick to also note that “the markets are a two-way street and we know that they will trade lower at some point. The question is when, and from what level. A pullback should be viewed as a positive development.” There are many terms for this — back and fill, consolidation, stabilization — but the general idea is that we hit a resistance point where sellers take profits for a while until the buyers regain support.
To be clear, a “pullback” is not a “crash.” There are already alarmist headlines after just two down days on Wall Street — and before that, Robert Pechter already called for a 100-year bear market. Keep your head about you and don’t get lost in the hype.
I remain convinced that tong-term investors probably don’t have too much to fear, since most economists believe 2013 will be better than 2012 — and that next year will be better than 2013. GDP and employment aren’t impressive, but if you think back to 2008 and 2009, it’s obvious that we are in a much better place.
Still, both the bulls and bears seem to agree we’ve bumped against a ceiling. Keep your powder dry and wait for the dust to clear.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP.