On Thursday morning, European Central Bank chief Mario Draghi delivered the “Euro-QE” bond buying stimulus program he had been hinting at for years.
The size, composition, and term were all largely as expected. And as has become typical for pretty much any major decision or announcement by a major central bank, U.S. stocks soared in response to erase their year-to-date losses.
But after shorting the market into its mid-January lows, I’ve largely recommended my clients move to cash and sit out the rebound that’s now underway. Examples include the 46% gain captured by Edge subscribers in the VelocityShares 2x VIX (TVIX) between December 1 and January 20 as well as the 74% gain in Facebook Inc (FB) January $77.50 puts bagged by Edge Pro subscribers between January 7 and January 15.
Why? There is simply too much volatility (as evidenced by the churning action in currency and commodity markets), with too many hurdles (the Greek elections on January 25 and the Federal Reserve policy announcement on January 28), and too many signs of weakness within the market.
Here’s a closer look at three reasons to sit out in this ugly market.
The chart above shows how market breadth — or the percentage of stocks participating to the upside — has been sliding lower all year as investors become pickier about the names they’re willing to buy. The narrowing buying interest is a sign of apprehension. And it’s a sign that, while the S&P 500 has returned to levels first reached in late November, it’s happening on a weakened foundation.
Currently, 63% of stocks in the S&P 500 are in uptrends, compared to the 76% reached back in November.
As analysts at Societe Generale note in the chart above, stocks are expensive. Especially high+quality names, which have reached valuations that were only exceeded for a brief time in the late 1990s dot-com meltup.
Historically, forward returns have disappointed at current valuation levels.
As an aside, this is all happening at a time when individual investor exposure to stocks — as reported in the AAII surveys — recently hit levels not seen since before the 2008 financial crisis.
And finally, volatility as measured by the CBOE Volatility Index (VIX), has been elevated over the last few months in a way that hasn’t been seen since the 2011 market correction. That’s a sign that options traders are paying up for downside protection. Only a decisive and prolonged break below the 200-day moving average in this measure — which is known as Wall Street’s fear gauge — would open the door to long positions.
But with all the moving parts investors must deal with in 2015, including the specter of the first Fed rate hike since 2006 and a Greek exit from the Eurozone, I don’t see that happening until the second half of the year.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.