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As Dow nears 17,000, the worrywarts still speak loudest

Daily Ticker

Maybe we should call it Wall of Worry Street.

Even as stocks stroll blithely through the neighborhood all-time highs, an abundance of investors are meeting Winston Churchill’s definition of a pessimist  seeing the difficulty in every opportunity. Rather than embracing and celebrating the bull market bounty, Wall Street seems to greet each new theme animating it as a worrisome omen of its undoing.

This is not one of those claims that “everyone is bearish” and therefore the crowd-humbling market will jet higher from here. For sure, on a very short-term basis stocks appear a bit frothily overbought and the mood of active traders has turned toward aggressive greed. This argues for a rest period or a scary little air pocket at minimum to let some speculative fizz dissipate.

But the broader market conversation is skewed toward the recitation of risks rather than opportunities. Commentators habitually rush to identify trends related to rising risk appetites and ample liquidity as fatal excesses. And, tellingly, each time we do get one of those smallish market pullbacks of the sort that might be in the offing now, angst over these supposed excesses comes right to the surface and stokes fears that the Big One is nigh.

The list of market attributes being offered as evidence of bubbly dangers grows weekly.

-Over the weekend, Mark Hulbert of Hulbert’s Financial Digest cited the full merger-and-acquisition pipeline as an indicator of a “dangerously overvalued” market. (That characterization, included in the headline, came from a European academic.) The late-2013 flurry of technology IPOs drew a similar display of finger-wagging toward investors supposedly blinded by greed.

-The extreme quiet in global asset markets has been presented as a harbinger of an imminent storm since before Memorial Day. Here’s a chart of news coverage of this phenomenon.

-The generous credit markets, with rates low and terms loose for corporate borrowers, are cast not as a sign of refreshed, central bank-supported lifeblood to the economy but as reckless underpricing of risk. Investors’ grab for such exotica as subprime auto-loan securities has raised alarm about a rerun of the mortgage bust.

-Stock buybacks, a central feature of this bull market for years now, are typically seen as a prudent, if unimaginative, use of excess corporate capital. Yet now that they are scooping up public shares at a near-record pace, some are worried that shareholder funds are being squandered on overvalued equity.

-The recent uptick in inflation  from extremely low levels and toward the range of the Federal Reserve’s long-term target – is likewise being presented as cause for anxiety. Fed Chair Janet Yellen last week dismissed such concerns as premature, calling recent inflation data “noisy,” which quickly prompted some inflation-fearing commentators to suggest she was already falling “behind the curve.” This debate is the new “noise” around inflation.

As Yahoo Finance Editor-in-Chief Aaron Task and I discuss in the attached video, there is no doubt all of this qualifies as late bull-market behavior, the kind of activities that gain steam after the corporate-earnings cycle has matured, money is cheap, financial decision makers start to play offense, and stock and bond valuations have fattened up.

And it’s understandable that investors, analysts and the financial media are striking a vigilant note as these trends come together. The greatest financial crisis in a lifetime, just six years’ past, followed a period of overheated credit markets, compressed financial-market volatility, some silly M&A deals and huge, ill-timed stock buybacks.

Yet all these things are typically well-justified sources of market strength for a good long while before they turn toxic. As noted here not long ago, most of these complaints can be described as a bull market acting like a bull market. It seems that today, everyone is not only fighting the last war but isn’t bothering to wait for the enemies to become threatening before issuing their warnings.

M&A, for instance, has peaked in past cycles when annual deal volume has approached 10% of world market capitalization. At this year’s pace, it will have just surpassed 5%.

Stock buybacks may decreasingly look like a wise use of cash for a growing business, but cheap borrowing costs and still-high hurdle rates for new capital spending make them a defensibly rational exercise.

Inflation, meantime, is part of the solution to a slow-growth, high-debt, excess-labor U.S. economy, and the Fed knows it. So this, too, is an acceptable good-until-it-gets-out-of-hand factor.

The low volatility and trading volumes everyone is chattering about are quite reminiscent of conditions in 2005 and 2006. Admittedly, those were the years when the exotic poisons of the credit and housing markets were being circulated widely through the system. But it took years of build-up and a steady ratcheting higher of official interest rates for it to fall apart.

Market themes morph from good to bad after a period when excesses build up, risks begin to get ignored for a while, leverage is piled atop shaky collateral and, often, when some shock or a shift in Fed policy undercuts lazy investor assumptions. Extrapolating current levels of market valuation, economic conditions, corporate profit margins and apparent Fed intentions continues to suggest that, eventually, we could end up in a bubbly place.

Part of the discomfort felt by investors as they regard these dynamics is that, after five years of a bull market supported by ultra-accommodating liquidity, there are few bargains, and assets that look attractive only appear that way next to another that seems quite expensive. A bullish investor at today's prices might well be implicitly betting on a typical "overshoot" phase that most bull markets reach before ending. 

When might we know that extreme worry is more warranted? Well, the St. Louis Fed Financial Stress Index, a monthly measure of market conditions, just made a new all-time low.

In the prior cycle, it made a low in early 2006 and then began climbing, but after it turned higher it was more than a year before the broader markets sustained any serious damage, so this is a decent signal to monitor as a shorthand alert system.

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