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"Just tell me when to start worrying, and why."
This command, delivered to an investment-strategist acquaintance by a client, neatly sums up the mindset of a lot of investors, who have witnessed the stock market evade (so far) the gang tackle of rising oil prices, more European debt drama, geopolitical strife and concerns about the coming withdrawal of the Federal Reserve's money-printing efforts.
This is another way of asking which bellwethers ought to be heeded most carefully in deciding whether to get defensive on stocks or betting outright against them.
The conventional-wisdom crowd is about to start buzzing about fading seasonal tailwinds with unclever plays on the "sell in May" rule of thumb. Others are voicing concern about the lethargic behavior of copper prices, which are down slightly this year, even as U.S. stocks are up some 5%.
Another contingent sees the slow-drip decline in the CBOE Volatility Index, or VIX, to below 16 as a convicting verdict on investors' dangerous complacency. This gauge suggests that the market isn't girded for any major shock, and it makes hedging stocks fairly cheap. But mostly what it conveys is that the indexes' actual volatility has been remarkably tame. And, in fact, the VIX in a downtrend generally augurs bullishly for stocks.
These things all bear watching, especially in a mature bull market with corporate-profit momentum waning, some weak responses to merely OK earnings reports emboldening the bears and the number of new 52-week highs sliding recently. Yet the weight of the evidence suggests that further setbacks won't be the start of a punishing retreat or an end to the bull run.
Ned Davis Research last week revisited its 11 reasons to be optimistic on stocks, detailed coming into 2011, and concluded that 10remain for now. These range from credit conditions (by NDR's measure they're stronger than they've been in four years) to valuation and technical measures.
A look at Friday's 52-week high list also shows that the leadership of cyclically geared names remains intact. The prevalence of consumer-sensitive and real-estate stocks is quite striking. Among them: Abercrombie & Fitch (ANF), Ann Taylor (ANN), AutoZone (AZO), CB Richard Ellis (CBG), Foot Locker (FL), Jones Lang Lasalle (JLL), Limited Brands (LTD), Polaris Industries (PII) and Weight Watchers (WTW). Some of these are held aloft by buyout speculation, but that in itself speaks to the support of copious liquidity and risk appetites.
Says John Roque, technical strategist at WJB Capital: "I wonder, in this environment, if the rails aren't as good a bellwether as we might need."
The rail stocks, as measured by Roque's own index of rail-industry leaders, are up some 10% this year, offering credence both to commodity-demand strength and the general global recovery story. An index of diesel-fuel consumption, the Ceridian-UCLA Pulse of Commerce Index—cited by Delta Investment Group as tightly correlated to stock prices—has also recently accelerated.
No one has the key to the market, but the best lock-picking tools are telling us that any further weakness is unlikely to be The Big One that so many investors fear.
INVESTMENTS WITHOUT TETHER to the general rise and fall of the financial markets are hotly coveted in these days of widespread Post Financial-Crisis Traumatic Stress Disorder. And yet, even so, some such plays still go neglected.
One instrument of this description quietly hit the market this month, a "contingent value right" security whose value is tied strictly to the fortunes of one drug developed by Genzyme, the biotech company recently bought by Sanofi-Aventis (SNY). Sanofi paid $74 per share in cash, plus the CVR linked to the progress of Lemtrada, a drug being evaluated for its effect in treating multiple sclerosis. The CVR trades on the Nasdaq under ticker symbol GCVRZ and closed Friday at $2.63.
Some hedge-fund investors have been drawn to the CVRs as a "noncorrelated" investment with a definable probability-based estimated value, yet without the cash-burn and operational risks of a typical biotech stock. The CVR's ultimate cash value, between now and its maturity in 2020, is based on production and sales milestones for Lemtrada.
The maximum value is $14 per CVR, if every sales threshold is met on time. Of the 10 analysts who have ventured estimates of the likely payout, the average present value of the likely end value is around $3.30, or 25% above the current price. Comparisons with roughly similar "all or nothing" instruments place the present value closer to $4.
E-mail: michael.santoli@barrons.com
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