After spending the last few weeks of the year, reading through dozens of “2011 Outlooks” from Wall Street’s finest Group Thinkers, Larry Jedoloah’s Market Intelligence Report provides investors with a break from consensus this morning. Unfortunately, for all those levered long risk assets anyway, we whole heartedly agree. As we explained in a recent note to investors:
With expectations still elevated, any unexpected developments should serve as a catalyst for a sell-off. We can imagine plenty of triggers, ranging from Chinese Inflation and the European Debt Crisis to US Housing Deflation and Currency Wars. As we discussed in our last Broyhill Letter, an abrupt decline that cleared overbought levels and injected renewed fear into the psyche of speculators might provide a better base for the typical Third Year Boom. We can’t rule out the possibility that investors will continue to speculate on the hope of ever larger deficits and ever increasing liquidity, but history is chock-full of examples where free money ended in financial ruin. Take for example, Ireland or Greece. Bailouts don’t change the level of debt that debtors owe; they just shift the creditors around. In our view, the risk profile of the equity market is extremely negative here as a growing number of worrying divergences point to sharply lower prices ahead. Dollar strength, emerging market underperformance, widespread complacency, rising interest rates and spiking credit spreads are just a few.
Signs of Exuberance Abound according to our favorite Dave, who warns that:
- The VIX index, at 17.5x, is back to where it was last April. Remember what happened next.
- Investors Intelligence bullish sentiment is back to where it was at the all-time market highs of October 2007.
- The non-commercial accounts on the CME have recently opened up a considerable net speculative long position in equities, particularly the QQQ’s (Nasdaq stocks).
- Market leadership is narrowing, as Bob Farrell has been busy pointing out.
- The number of short-selling positions slid 2.2% in the first half of December on the NYSE; and by 2.8% on the Nasdaq. The bears are running scared.
- As Kelly Evans asserted last week, the AAII investor sentiment poll has been above its historical norm now for 17 weeks running ? the longest stretch in six years.
- Since July, margin debt has exploded by 16% to $274 billion, the most since September 2008 when people still thought we were in a soft landing.
- Equity mutual funds and ETF’s took in $24 billion in December (TrimTabs data). As an aside, the last time we saw retail inflows like this inequities was last March … just ahead of a 17% correction.
Risk assets have become extremely correlated and the market is clearly exhibiting a herding behavior that has historically been associated with a very negative skew of returns. Additionally, the 100 basis point spike in interest rates has created an extremely hostile environment for stocks, particularly when combined with a market that is overbought, overloved, overvalued and overdue for an abrupt decline. Stay sober in your thinking and resist the temptation to drink from the funnel of excess liquidity. There will be better times to invest.