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Our "Love-Panic" contrarian market sentiment index (combining a variety of factors predictive of 6-month equity returns in the last few years) is now showing its strongest warning of complacency in the U.S. since pre-Lehman. There could be some base effects impacting the index at the moment given the roughly 3-year rolling analysis period dropping out a lot of 2008/9 data but nonetheless, many factors are beginning to align suggesting excess complacency/confidence in U.S. markets at the moment.

When looking for a fundamental catalyst to surprise the markets, there are obviously many from Italy/European issues to politics in the U.S. and Chinese credit tightening measures but the one that popped up on Friday was of interest. U.S. incomes fell dramatically due to the 2% payroll tax increase and the reversal of the pre-fiscal cliff "bonus" of dividends brought forward, etc. The consequence is that U.S. consumers in January saved only 2.4% of disposable income - the lowest level since pre-Lehman.

With the government clearly no longer supporting consumers to the same extent and mostly focused on withdrawing support (sequestration), U.S. incomes aren't likely to be well supported in the near term and with such a low savings rate, consumption may struggle to grow, too. Remember that consumption is about 70% of U.S. GDP, so weakness here suggests ongoing weakness in U.S. GDP, too.

The January NYSE margin for debt data showed investment leverage also nearing historic peaks. The combination suggests there are few drivers of higher valuations or better fundamentals in equities at the moment. These factors lead us to suggest that the chances of positive 6-month returns on the SPX are now very low and the chances of a meaningful (10%+) draw-down are heightened.

While the model output of a 28% draw-down is probably excessive in an environment of QE-ternity and much more appealing relative valuations versus bonds than in 2008, it seems sentiment and fundamentals may be tested in the coming months.

Source: 'Love-Panic' Highlighting Complacency Risks