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Stocks’ Lull Fails to Quiet a Shrill Bull-Bear Debate

Michael Santoli

Perhaps the market gods are conducting the perfect group-psychology experiment on Wall Street, setting stocks on a beguiling and mostly unexpected climb over the past few months, just to watch the emotions and rationalizations flare as they decide how to administer comeuppance.

The lab conditions were set late last year. Political and economic anxieties were pumped, under high compression, into a market trying to assimilate an election that went against many big-money wishes and led directly into a mock-momentous fight over tax rates and government solvency.

The stock market was completing a decent year, as the Federal Reserve’s multiyear campaign to smother financial volatility gained purchase. But it felt fragile, having endured gut checks of 9% to 20% in each of the three prior calendar years. As a result, the appetite for buying protection against another market panic was voracious.

With investors tightly clenched up, the prevailing predictions entering 2013 were for a merely OK year: Weak at first and better in the second half, all dependent on real, substantive progress on long-term fiscal issues. Well, this is not quite what occurred. On cue, a slapped-together, stopgap fiscal deal that bought a couple of months of status quo opened the way for the strongest January for stocks in nearly two decades.

Protection overload

Investors entered the year loaded with protection that quickly felt heavy and ridiculous, like scarves and earmuffs in a heat wave. The shedding of these insulators has accounted for some unclear portion of the market’s vaunted resilience and calm of late.

The optimists are extrapolating the 6% year-to-date gain in the S&P 500 index as the overture to the long-promised revival of the public’s romance with equities, interpreting the market’s refusal to ease back as evidence that waves of new money will float all boats.

The skeptics, meantime, are taking note of the little-changed economic backdrop and rampant evidence of excessive cheeriness among traders and investors, watching the market as they might a brick floating in a pool, confused but still sure it will sink.

A round-and-round argument

As the S&P 500 has hovered lazily in a 2% range since first reaching the 1,500 mark more than two weeks ago, the argument among bulls and bears, correction-callers and dip-buyers, has gone around enough times to double back on itself, with too many claiming that “everyone else" is holding to trendy, lazy assumptions and oversimplifying things for their purposes.

One of the striking elements of this argument is that it’s over a relatively slim patch of market turf. Even with this heady sprint so far in ’13 and the 12% rise since mid-November, the S&P 500 is less than 4% above where it peaked in mid-September, a rounding error in the grand scheme.

Market behavior itself shows minimal selling pressure so far, stout-looking uptrends, healthy reactions to decent corporate results -- all in the context of central banks around the world underwriting risk-taking with cheap money and governments trying to suppress their currency values. The burden of proof on those predicting deep and enduring declines is pretty high.

Still, there is no evading the fact that most every time-tested measure of investor attitudes is in a zone that suggests too many folks are too comfortable playing for further upside. Whether the Citi Panic-Euphoria index, the various weekly surveys of newsletters, stock exposures of active money managers and scores of other clues, the sentiment environment seems a bit too upbeat for the rally to extend itself much from here. BofA Merrill Lynch even debuted a new Bull & Bear index in time to show the mood is more ecstatic than 99% of all readings since 2002. At minimum, a negative turn in economic news or some other surprise would catch investors badly wrong-footed.

An ambiguous reality

And yet, even with all that, the market mood is not so out of line with the reality that the market ticked to a five-year high at a time when many of the scary, existential economic and policy threats of the past few years are in abeyance.

So, unsatisfying as it is, we are left with ambiguous reality: A sturdy rally under general financial conditions that suggest the market is well-supported -- yet one that’s overbought, maybe overconfident, overdue for a shakeout, betraying subsurface weakness in bonds and aggressive sectors.

Perhaps hardest to plumb is the fact that these excited sentiment signals are getting so much attention and air time. It seems an outsized number of traders and commentators are trying to be clever by outsmarting what they believe to represent the “dumb money” majority.

This mode of trying to sidestep popular attitudes, to out-anticipate the moves of other anticipators, is a widely shared and deeply ingrained habit of the crisis-rescue-relapse pattern of the past few years.

Promising “absolute returns” regardless of market direction, assuming little help from multiyear market trends, this mindset implicitly assumes a zero-sum game, in which returns are extracted from slower or mistaken competitors rather than harvested from the market’s generous bounty.

It’s too soon (or takes too much courage) to say whether the markets are transitioning out of this mode and into a more inclusive, forgiving climate – a shift from a “Lord of the Flies” kill-or-die ethic to one more like “Survivor,” in which winning and losing are relative, everyone actually survives and most get a little something for their effort.

The expressions of frustration by many wised-up professional traders at the market’s refusal to succumb to a surfeit of happiness imply that the crisis-shadowed, policy-dependent approach endures. If stocks continue to march higher, these embittered pros might be forced to recognize one decent working definition of a strong bull market: One where not-so-bright people make money along with most everyone else, for a while.