In case you haven't noticed, a number of warning signs have cropped up in the market in recent days and weeks. One is the disturbing tendency of the market to open higher, even strongly so, and then reverse. This was unheard of in 2013, not without some major headline crossing the tape (e.g., Bernanke announcing last May that hey, maybe we'll be done with QE by this fall).
A second has been the rotation out of high-beta names into low-beta. Some of it has been attributed to people cashing out of overvalued cloud stocks to buy even more overvalued IPOs, but I think it's more than that. The chart below shows a sudden burst of outperformance by the value tier (IVE, top line) of the S&P 500 (middle), led by the surge in "old tech" stocks like IBM. Bio-techs have been getting crushed, with the IBB down 14% in the last month. I've seen this kind of rotation before, and it wasn't to buy money-losing IPOs.
Popular mo-mo names are suddenly getting hammered: Priceline (NASDAQ:PCLN), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), Salesforce.com (NYSE:CRM), all down by more than 10% in the last two or three weeks. The list is longer than those names, and suddenly the Russell 2000 has started to underperform as well (bottom line in chart). When you see money leaving those sectors to huddle in big cap value names like IBM or Hewlett-Packard (NYSE:HPQ), that's a major defensive rotation.
Then there's an IPO bust like King.com (BATS:KING), down over 10% from its IPO price at the close of trading. Regardless of the merits of the deal (and King.com actually makes money), it would have done better in a more confident market. Many took it as a signal to leg it.
I've consistently been warning that the market is overvalued, but not yet on the verge of the big one. In late January I wrote on SA that the stock market was not yet beaten, despite the bad omen of the drubbing it took that month, that a rebound to 1850 was still in the picture, and that while we were overdue for a trip to the long-term trendline on the S&P 500 (then at about 1500, now 1550), I didn't think we would get there this quarter. I don't think we're about to get there in the next few weeks either, not yet.
I did say last week on Alpha that a window of vulnerability for the market had opened, and we do seem to be climbing through it. Stocks are setting up for another 5%-10% pullback like the one we had back in January, and the period from the latter part of March through the first half of April is certainly one prone to these kinds of setbacks.
But it just isn't the time of year for crashes. That may seem like a dubious layer of protection, but take it from one who's been through a lot of crashes - stock prices just don't crash in the early spring. A weak start to the year can definitely signal trouble at the foundations, as happened in 2000 and 2008, but even in those years, the markets turned around sometime in April and rallied. The rally that comes at the beginning of first-quarter earnings season is a time-honored tradition that's almost as old as the stock market itself.
First of all, there is the ritual of estimate beats (earnings growth estimates for this quarter have been cut from over six percent to just over two percent in the last few weeks) and the promises to make up any shortfalls in the second half of the year are still possible. Don't forget the calendar, either - April is historically the best month of the year for stocks, and algorithmic trading tends to emphasize historical patterns.
Sometimes the rally dynamic starts to come apart in early May (or even late April), but from today's vantage point, I don't see that particular development as the likely one this year, not unless the April jobs report is a total loss. Even that could give way to a hope rally on the notion that the Fed would be obliged to halt the taper - keep in mind that what strength the market has seen of late is still as stimulus-based as ever, whether from the Chinese central bank (the knee-jerk reaction to another weak and declining PMI) or the European Central Bank (ECB), where even the Germans are floating the idea of asset purchases.
There is enough weakness at the foundation of the accelerating-economy theory to again have strong doubts about this year being (finally) the one. Business capital spending is up only 0.1% in the first two months of 2014 versus the same period in 2013, and even that's only in nominal terms - after inflation, it's negative. I simply can't see weather playing the lion's share of the role in the category (even BlackRock's Larry Fink is complaining). A second leg, that of housing, isn't happening yet either. New home sales are flat through the first two months of 2014, and mortgage purchase applications are down 17% year-on-year.
But there should be a rebound in equity prices sometime in April. Not from this month's data - the weekly chain store and mortgage reports don't point to strength in either retail sales or housing. The late Easter is already being blamed for a weak March, and while that makes sense on a year-over-year basis, it doesn't make any at all on a month-to-month basis. Some are hoping that the strength in the consumer confidence report reflect a better labor market, but the claims data suggest a weaker adjustment factor.
As we get into May, though, the view (for now) looks promising. Easter is going to boost April retail sales and any warming trends in the weather should help out on hiring and sales in the categories of construction, leisure and entertainment. The markets will still be very eager to embrace the possibility that it was all a bad-weather dream, and the marketing machine will be ready to start up a deafening parade of I-told-you-so's. Perma-bulls will be on CNBC literally shouting vindication at the cameras, I can assure you now.
Some danger on that victory path remains, beginning with the obvious one of the outbreak of shooting in the Ukraine. Beyond the geo-political possibilities, there is also the risk that the rebound gets over-anticipated and reports do not quite meet whisper expectations. The stock market does like to frustrate the maximum number of people.
I think it more likely, however, that we will see the typical kind of rebound rally that follows a shaky early spring, even if the current anxiety does develop into a full-blown 10% move downward before it's over. Should the latter happen, then a rebound attempt could get added fuel from the ECB meeting early in May, since choppiness in the US and continued weakness in the European economy could push the bank into finally taking its turn at the asset purchase wheel. Throw that in with some happier sales data, however ephemeral, and we could be looking at new highs again.
The drawback to that is that stocks would end up back in the severely overextended zone while heading into a more vulnerable part of the calendar. It would take quite a shifting of gears in the economy - not at all visible at this time - to redeem the promise of new highs. But the stock market has always worried about that aspect later. After all, the trend is your friend - until the end.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am short the Russell 2000