Caution in the Stock Market

February 4, 2013

While the major indexes did advance on the week there are a few signs that should give investors pause.
-David W. James, director of research, James Investment Research

Conclusions: A few short months ago our indicators frolicked in the favorable camp. This came despite the gnashing of teeth over the fiscal cliff crises. We noted there was simply too much pessimism and that stocks would instead rally. This week proved the indicators correct with the Dow Jones crossing the 14,000 for the first time since 2007.

However, while the major indexes did advance on the week there are a few signs that should give investors pause. Advancing stocks instead of leading a blistering path forward were nearly matched by declining issues. Further the heaviest trading day of the week, Thursday, was generally a down one for the Dow and the S&P 500.

Other market troubles include the change in investor attitude. When our indicators had turned favorable the nation was gripped in fear. Now? Enthusiasm rules the day. The VIX, often seen as a fear gauge, is under 13 suggesting almost no fear at all by traders. Surveys performed by AAII show fewer than 1-in-4 investors have a bearish outlook; a very low number. Additionally, the Investment Company Institute reports that January is on a record breaking pace for deposits into mutual funds. These are signs of euphoria; not a market bottom.

Some excitedly point to Friday’s employment number and almost giddily suggest the good times are here to stay. In truth it has now been 61 months since the Great Recession started back in December 2007 and we are still 3.1 million jobs away from being at our old employment levels. Further, for there to be big employment gains in the future we must look to the entrepreneur class. In January our country lost 189,000 entrepreneurs as heavy handed regulations and higher taxes caused a number of these individuals to throw in the towel.

We continue to see evidence that corporations and individuals worked to alter their situations. Generally, they looked to take action in a more accommodative 2012 rather than face a more punitive 2013. Given that the fourth quarter featured negative economic growth it is likely 2013 will be a bumpy ride with the economy and stocks facing breath-taking periods of strength and capitulation.

Presently stocks are in a peaking phase. As we noted last week, our indicators suggest we have not reached a final top; however the leading intermediate indicators are no better than neutral and have declined from strongly bullish. It is still too soon to initiate massive sales but we would take advantage of extended prices to trim weaker stocks.