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A GOOD WAY TO CUT THROUGH ALL THE forced good cheer of the holiday season is to enter the New Year with a peevish and disputatious spirit. As an excuse to take up a few relevant market themes, here are a couple of complaints about some notions that are getting far more play than they deserve.
First is the fairly common thought that Treasury yields are sure to shoot higher, and that this would represent kryptonite for the stock market. Because the idea that rates must climb significantly is plausible, it's very popular. A survey of the 18 primary dealers in Treasuries shows that all but two forecast that the 10-year note's yield will be flat (around 3.75%) or higher at year end, with a median forecast of 4.125% and a high of 5.5%.
Yet the Dow and Treasury yields have been rising in tandem since March, and higher yields for "good reasons" such as steadily better economic data wouldn't undermine stocks. In this context, one might even say stocks "need" the circumstances that would drag rates higher.
Of course, there's some level of Treasury yield that would thwart any equity rally, but it's neither easily knowable nor likely very close at hand.
Another widely shared misapprehension is that the decline in the CBOE Volatility Index, or VIX, below 20 and to a 19-month low is in itself proof that investors are blithely complacent, given an unwillingness to pay up for the options protection that VIX gauges.
Not so. More than anything else, the persistent drop in the VIX reflects the collapse in actual day-to-day market volatility, the key input into options prices. In fact, the index-options prices that the VIX tracks still appear "overpriced," based on the market's actual variability, as has been true for months. Like the microwaves that remain as a residual of the Big Bang, an anxious energy pervades the markets as a vestige of last year's extreme market movements, supporting demand for protection.
This doesn't mean that general investor optimism and comfort haven't been on the rise. They have. I've argued for months that the public was abidingly skeptical of the rally and the wall of worry remained reassuringly high. That's less so now than it's been since the market lows.
Most market-psychology indicators are upbeat -- a cause for potential concern, given that the market is no longer cheap, but they're not yet reflecting the extreme frothiness and greed that typically punctuate a bull run.
The widely cited Investors Intelligence survey of advisors shows a quite-high ratio of avowed bulls to bears, though this is mitigated somewhat by the unusual abundance of respondents expecting a correction. Retail-investor surveys also show above-average cheeriness. And some days last week, historic volumes of bullish call options traded, signs of percolating speculative juices.
Yet this pickup in spirits among highly engaged investors is countered by an unceasing sourness among most of the business press (evident to anyone who shuts off the TV). And there have been virtually no net inflows into stock mutual funds lately.
Which brings us to the current stance of the mystery forecaster written up here a few weeks ago (Streetwise, Dec. 14), a broker who declines to be identified but who presciently called the 2007 market top and last April became aggressively bullish. Many have asked for his identity, but the best I can do is convey his thoughts.
He's playing for a final thrust higher, at least to 1200 on the S&P 500, probably in coming weeks, as the remaining skeptics jump in and an overbought market gets more so, and then sees a sharp decline coming, according to a Jan. 4 dispatch.
The ultimate correction, he thinks, will get to 10%, which would feel more painful than restorative while it's happening, but wouldn't mean a resumption of the mega-downtrend from 2007, instead giving way to a big year-end rally. And, in deeply contrarian fashion, he sees the U.S outperforming emerging markets, supported by a rising dollar.
His pick for the best-performing Dow stock of 2010 is General Electric (ticker: GE), a call that came before an analyst's upgrade last week goosed the stock nearly 10%. The stock is neglected, under-owned by pros, flattered by still-strong free cash flow.
I'm alert to the prospect that even this attention has top-ticked the anonymous broker's genius, but his sort of clear-minded analysis will remain worth a listen, even if so.
E-mail: michael.santoli@barrons.com
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