There's Too Much Complacency in the Market

08/01/2013 12:00 pm EST


Howard Gold

Founder & President, GoldenEgg Investing

August may be considered the one month where investors can sit back and relax, maybe even under a beach umbrella, but MoneyShow's Howard R. Gold thinks that doesn't mean to stop being on the lookout for what might be right around the corner.

It's August and the dog days of summer are officially here.

That means money managers, traders, and hedge fund operators have decamped for the beach, leaving Wall Street looking like an empty canyon. Even the financial media have dialed things back a bit as the news cupboard is pretty bare.

Earnings season is winding down, President Obama has delayed his choice of a new Federal Reserve chairman or woman until the fall, and Congress is headed for recess. The Federal Open Market Committee, which announced Wednesday it would maintain current policy, won't meet again until mid-September.

So, barring two jobs reports and the sudden appearance of black swans, there's almost nothing important investors need to worry about over the next few weeks—except their own complacency. With several indexes at or near all-time highs and with trading volume deeply depressed, investors are taking things too much in stride.

Bullish sentiment is rampant, the CBOE Volatility index (VIX) is bumping along its recent lows, and price/earnings ratios for stocks are entering high, if not nosebleed, altitudes. That makes things ripe for a decent correction after a surprisingly strong summer rally.

On Thursday morning, the Dow Jones Industrial Average hit a new record, and so did the Standard & Poor's 500 index, which topped 1700 for the first time. The small-cap Russell 2000 also is just below its recent record high.

But investors appear to be taking it for granted. In July, $17.5 billion flowed into US equity mutual funds and ETFs in one week, the most in any week since June 2008. Meanwhile, investors pulled $75 billion from bond funds over a six-week period, reversing a five-year-long trend. What were they waiting for?

And recent polls of institutional and individual investors show great confidence, even overconfidence, the market will continue to move higher.

Investors Intelligence recently reported that 52% of the newsletter writers it polls were bullish and less than 20% were bearish. That was the highest percentage of bulls and the lowest number of bears since May.

Two respected surveys of professional investors—Consensus and Market Vane—indicated bullish sentiment of 67% last week; it's been rising for several weeks.

Next: Individual investors are too bullish


And the American Association of Individual Investors, which surveys active individual investors, showed bullish sentiment at 45.1% last week, while 22.6% of its members polled were bearish and 32.2% neutral. That's well above the long-term average of 39% bulls and below the average of 30.5% bears.

In mid-July, AAII's bulls topped bears by 48.9% to 18.3%, a 30-percentage-point gap that should have set off contrarian alarm bells.

Meanwhile, the much-watched—maybe too closely watched—VIX Volatility index fell below 13 Thursday morning, a bit higher than the June 22 low of 12.29. A year ago it stood at 16.27.

It's also way below its recent peak of 81 during the financial crisis. (It reached 45 in 2010, before heading steadily lower.)

I don't think the VIX is that good a predictive indicator, but its low level now suggests there's not much fear in the hearts of traders.

Nor among fundamental investors, if you look at current multiples. The S&P 500 now changes hands at nearly 19 times the previous 12 months' reported earnings. That's way above where it was last year at this time—as are the P/Es of all the major Dow Jones indexes. And the Russell 2000 trades at almost fifty times trailing-12-months earnings and looks way overextended.

Even the widely-followed, cyclically adjusted price/earnings ratio (CAPE) developed by Yale's Robert Shiller and Harvard's John Campbell, is flashing yellow. CAPE measures stock prices by inflation-adjusted earnings over the previous ten years, and “ has a far better forecasting record than the traditional P/E,” wrote Mark Hulbert, who added: “The CAPE currently stands at 23.6, according to Shiller. That is higher than 90% of comparable readings since the 1870s.” Shiller himself advocated buying stocks at a similar CAPE earlier this year because of the paucity of other options for investors. He's been right so far, but at some point multiples like this catch up with investors.

I don't know if this bull market is over. People who've been right about it for years—Jim Stack, Laszlo Birinyi, James Paulsen, and Sam Stovall—say it has a way to go. And you can never predict when any correction is coming, so you shouldn't sell more than a small part of your stock holdings if you think one is at hand.

(My own advice to sell in May and go away was correct for about five days in June before it turned—well, premature).

But I believe the stars and the data are pointing towards, at least, a decent correction of markets that have come, too far, too quickly. The markets need a summer vacation, too. Let's hope they don't go too far south to bask in the sun.

Howard R. Gold is editor at large for and a columnist at MarketWatch. Follow him on Twitter @howardrgold and see his workshop, "Your Ideal ETF Portfolio for Now," at the San Francisco Money Show, August 15-17. For more details, click here.

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