Amid the lowest non-holiday volume since last summer, stocks inched higher to close the S&P 500 Index above the 1,900 level for the first time ever.
There was no particular catalyst for the move. And it wasn’t confirmed by other measures of market health.
Instead, as I discussed in a recent post, just a general sense of ease and complacency as market volatility dwindles to record lows. Closing up on any given Friday is a vote of confidence. Closing up ahead of a long holiday weekend that will feature elections in Europe and the Ukraine — amid reports of shots being fired between North and South Korea — might very well border on overconfidence.
Breadth has been lackluster (up-volume accounted for only 68% of total NYSE volume today, down from 84% last week and nearly 90% at the beginning of March). Long-term bond yields keep drifting lower as fixed-income traders send out warning signals. And let’s not forget that while the S&P 500 bagged 1900, it was by the hair on its chin (half a point) and represents a level from which it was turned away two other times since April.
The fundamentals aren’t exactly wonderful either. Sure, housing has stabilized thanks to that drop in long-term interest rates. But first-quarter GDP is set to be revised into negative territory, retail sales are disappointing, inflation is drifting higher, and consumers are sucking down their savings and turning once more to short-term credit to pad their budgets.
What about corporate earnings? That’s topic is worth a full-length column of its own. But to understand what’s happening here, just look at what happened today with Hewlett-Packard (HPQ). Shares jumped more than 6% after initially trading lower Thursday afternoon following the announcement of weaker-than-expected top-line results and dour forward guidance. Why? Because it took the bulls a little while to celebrate the announcement of deep job cuts and a large expansion of its share buyback program.
This mechanism — share buybacks often funded with the issuance of cheap debt — has been the primary way the Federal Reserve’s ongoing cheap money stimulus has inflated what increasingly looks like another stock market bubble.
But it could be ending. According to Capital Economics, since the beginning of 2008, a subindex of the 100 S&P 500 stocks with the highest buyback ratios has nearly doubled; compared to the 30% or so rise in the overall S&P 500 over this period.
So far in 2014, the buyback index is lagging behind. Perhaps — as in the case of companies like IBM (IBM) that are now suffering from ballooning debt-to-equity ratios that put their credit ratings at risk — investors are realizing there is a limit to how long this game can go on.
And finally, it must be noted that much of the market’s rise over the past week has been driven by a collapse in volatility expectations as represented by the CBOE Volatility Index (VIX), which fell today to levels that have only been seen one other time (briefly in early 2013) since the market was topping in 2007.
As a result, the VIX has been stuck under the 15 level for more than a month and is well below its 50- and 200-day moving averages. According to Jason Goepfert at SentimenTrader, over the last 30 years market history suggests, with a high probability, that a 20% increase in the VIX is to be expected in the coming months.
There have been 15 other occurrences like the current one, and in every single case the VIX at some point over the next month jumped more than 13%. And it jumped more than 20% every time with a median gain of 45% at its highest point.
What this means is that there is a 100% probability that the VIX closes below 14.4 at some point by late August with a move above 17.4 likely based on this data. And as the VIX increases, stocks will fall.
Click to Enlarge With short positions against the VIX quite extended, and general market complacency so high, the turnaround is sure to be vicious.
Which means that S&P 500 1,900 might not last and that the Russell 2000 small-cap index, which is down more than 7% from its high, might be telling the truer story of where things stand.
Click to Enlarge Or the fact that just 60% of the stocks in the S&P 500 are above their 50-day moving average — down from 70% last week or 85% at the beginning of April in a downright hilarious narrowing of buying interest.
The catalyst could come as soon as this weekend, with anti-euro parties ahead in the polls in Greece and Russia watching wearily as Kiev tries to restore control over its eastern regions.