There's a Bull Market Right Now in Complacency
"In bull markets, there is no clear demarcation between progress and fantasy. 'Find value, always' is as good a precept as any, but value is subjective and its definition is liable to change. In highly speculative markets, value means 'it is going up.' One must stay abreast."
-- James Grant, Minding Mr. Market
Stock prices have risen back to the recent trading range's high end, driving the doubt from Wall Street. A deepening complacency has surfaced yet again despite ambiguous global economic and profit data.
Buyers are living higher and sellers are living lower in an investment world that's starved for performance, with quant funds and other price-momentum strategies dominating the landscape. Despite more than seven years of monetary easing that's failed to sustain economic growth, investors' faith, confidence and dependence on the world's central bankers remain unaltered.
But to this observer, the data do matter. Like Indianapolis 500 winner Alexander Rossi crossing the finish line this past weekend on an empty gas tank, the U.S. stock market looks to me like it's running on the fumes of rarefied valuation levels.
Let's look at the evidence:
Fundamentals
The U.S. economy has failed to reach "escape velocity," and a sales-and-profits recession remains in place.
As Hedgeye Risk Management recently noted, U.S. manufacturing figures are also worsening. Yesterday's Chicago Purchasing Managers Index came in at 49.3 vs. 50.4 the previous month, while the Federal Reserve's regional manufacturing surveys have all fallen.
Our flat yield curve -- where the spread between two-year and 10-year Treasury yields is down to just 95 basis points or so -- is another significant warning sign, as this chart that Hedgeye put together shows:
Source: Bloomberg, Hedgeye
U.S. consumer confidence is also rolling over, as this chart indicates:
Source: Bloomberg, Hedgeye
Other Warning Signs
Additional worrisome indicators that I see include:
* High Valuations. The S&P 500's valuation is at a lofty 25x GAAP earnings.
* Overly Optimistic Sentiment. Although surveys show that outright bullish investor sentiment remains muted, few investors expect a correction of much consequence.
* Political and Geopolitical Concerns. Risks abound. As citizens and investors we aren't as safe as the markets presume.
My Positioning
I've recently expanded my net-short exposure yet again to reflect my personal rejection of the "Bull Market in Complacency."
The S&P 500's close at 2,096.96 yesterday is about 13% above my 1,860 fair-market-value estimate for the index. As such, the market's risk-vs.-reward quotient looks substantially unfavorable to me.
While I've generally emphasized individual-stock shorts over index shorts, I recently initiated shorts in the Materials Select Sector SPDR ETF (XLB) and the Consumer Staples Select Sector SPDR ETF (XLP).
Geographically speaking, I've also shorted the iShares China Large-Cap ETF (FXI) and the iShares MSCI United Kingdom ETF (EWU).
While I usually see the phrase "Sell in May and Go Away" as a silly, glittering investment generality, it might prove to be a profitable strategy in the months ahead!
