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Even the bulls see a market pullback Add to ...

The S&P 500 suffered its biggest one-day tumble of the year on Wednesday and was down another 11 points in early trading on Thursday – taking it, if only briefly, below the 1500-point threshold and raising the natural question of whether a correction is in the works.

Sure, two days of declines merely brings the benchmark index back to levels seen in early February. And the overall dip from its five-year high on Tuesday amounts to just 2 per cent, which is hardly catastrophic.

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Yet, you can’t help but wonder if there are more declines ahead, for reasons that go beyond a fear of heights.

Consider, for example, the level of apparent complacency in the stock market. The CBOE volatility index – or VIX, a fear-gauge that rises as investors turn nervous about the S&P 500 – recently slid to 12.3, or its lowest level since 2007. This suggests a tremendous lack of concern on the part of investors, even as Washington continues to debate spending cuts that could have a big impact on the economy.

Meanwhile, the economy continues to limp along. On Thursday, U.S. initial jobless claims rose to 362,000 from 342,000 in the previous week, dashing expectations.

And the Federal Reserve is hinting that the era of open-ended stimulus, in the form of bond buying, could end sooner than expected. In the minutes from its last monetary policy meeting in January, released on Wednesday afternoon, some Fed officials expressed concern about the impact on the financial system. Previously, investors had bet that the stimulus would continue until the U.S. labour market improved dramatically.

This new uncertainty arrives as the S&P 500 explores five-year highs, with some strategists convinced that it will soon hit a new record high amid decent profit growth, renewed investor interest in stocks and an improving economy.

Yet, lofty expectations appear to be built into stocks already. While the tradional price-to-earnings ratio points to reasonable stock valuations, the Shiller P/E, which uses 10-year averages for earnings to get around business-cycle fluctuations, suggests that stocks are expensive.

So how bad will things get? Even bullish observers are expecting stocks to decline in the near term: “On the surface all is sweet,” said Michael Hartnett, chief investment strategist at Bank of America, in a note. “Market volatility has been conspicuous in its absence, while risky assets such as equities and commodities are handsomely outperforming bonds year-to-date. But we remain convinced that, sooner rather than later. a pullback is likely across risk assets, and indeed would be very healthy for the longer-term reflation story.”

The bearish case, presumably, is far more dire.

Follow on Twitter: @dberman_ROB

 
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