Equity markets have had an excellent run over the past few weeks, with the S&P 500 and Dow Jones climbing to multi-year highs. However, a correction could be on its way as the S&P 500 now has been in overbought territory for a couple of weeks now.
Robust Earnings Lift Sentiment
In the last one month, the S&P 500 has gained 4.78%, the Dow Jones has gained 4.87%, and the Nasdaq has gained 4.68%.
Stocks have been gaining momentum as the earnings season has turned out to better than expected so far. However, it must be noted that expectations ahead of the earnings season had been quite low anyways. Also, some robust U.S. and global economic data has lifted investors' sentiment.
The last minute fiscal cliff deal also boosted sentiment even though the deal was only partial and lawmakers are still to find a resolution to long-term spending cuts. Another major concern has been the debt ceiling issue, however, House Republicans on Wednesday voted to suspend enforcement of the debt ceiling through May 18th.
While House Republicans have voted to suspend enforcement of the debt ceiling through May 18th, a concrete deal is yet to be done. Also, the U.S. economy still faces the prospect of significant automatic spending cuts on March 1.
As I said, the earnings season has been better than expected; however, the bar was set too low in the first place. And while the economy is improving, the recovery is still in nascent stage.
Despite all these factors, markets have been surprisingly resilient. Technical indicators have been suggesting a pullback for a while. Also, with the S&P 500 and Dow Jones climbing to multi-year highs, one would expect a correction. However, it seems right now that the thinking among investors is that nothing can bring down the market.
VIX Below Historical Average, Gold Prices Flat
The Volatility Index or VIX, which measures the implied volatility of the S&P 500 index options, has been in oversold territory and trading well below its historic average of 20. The VIX is trading at levels last seen before the financial crisis. The iPath S&P 500 VIX Short Term Futures TM ETN (VXX) has fallen nearly 30% in the last one month. VXX hit an all-time low of $22.55 on Wednesday.
Gold prices have been trading in a tight range for a while now as investors continue to take safe-haven bets off the table.
Both the VIX and gold suggest that it is a good time to get into riskier assets; however, investors have been too complacent. As I said, the S&P 500 has been overbought territory and a correction is on its way. So what could push markets lower?
Reason to Dip
Equity markets have been overbought and are looking for a reason to dip. On Wednesday, market participants got that reason. After market close on Wednesday, Apple Inc. (AAPL), the Cupertino, California-based technology giant, reported disappointing quarterly results. The stock plunged nearly 10% in after-hours trading on Wednesday as investors digested the company's first-quarter results.
Although Apple reported record quarterly results, the company's revenue fell short of expectations. Analysts and investors were also disappointed by the company's outlook.
Apple is likely to drag the broad market lower in trading today. However, I believe that the correction is much needed. At current levels, stocks look expensive and a sharp correction will bring markets to a more reasonable level.