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Complacency is sweeping through the stock market

Brian Sozzi
Editor-at-Large

Investors could be getting too fat for their britches.

Across an array of asset classes, there’s no question that a lot of what Wall Street titans call “easy money” has been made this year. Ride-hailing firm Lyft, which has a No. 2 market share in the space, saw its first trade on the sizzling Nasdaq Composite on March 29 at $87.24, above its $72 IPO price. Slow-growing consumer companies such as McDonald’s and Hershey also find their stocks sniffing 52-week highs. The Dow Jones Industrial Average, Nasdaq and S&P 500 are closing in on the record highs achieved with great fanfare in August 2018.

Whether the appreciation in risk asset values is due to the Federal Reserve promoting Helicopter Ben Bernanke-like monetary policy for as far as the eye could see — or investors are betting for a spring revival in global growth — indeed the action in markets wreak of the stench known as complacency. Good old-fashioned, get punched in the face amid a dose of bad news type of complacency.

It’s almost laughable, until it isn’t

If the Fed secretly wanted to prop up the stock market after its December 2018 swoon, it has done a masterful job. Actually, it has done a superbly splendid job in getting investors to ignore risks within certain asset classes and swing for the fences in the pursuit of massive gains.

Apple’s stock is up for two straight weeks, 14% in the past month alone. How can one rationally think Apple’s most recent quarter will be meaningfully better than its ugly holiday season report card? China is still likely a weak spot for Apple and smartphone demand remains sluggish.

The Philadelphia Semiconductor Index (SOX) reached a record high late last week, despite a global economic growth slowdown that has caused chip inventories to remain elevated (which has kept prices under pressure). If that isn’t complacency on the part of investors then color me silly.

Meanwhile, the CBOE Volatility Index (VIX) is back around the lows seen in fall 2018, just prior to the market tanking as investors reassessed risk assets. Ultimate complacency.

“A rapid rise in asset valuations and plunge in volatility point to creeping market complacency,” cautions the investment strategy team at BlackRock in a new note. BlackRock is advising clients to stay selective in these inflated markets and use rallies in stocks to “dial back” exposures.

Some of the risks ahead deserve to be priced more into asset valuations. Unfortunately, they are largely being ignored by the masses. BlackRock thinks a resurgence of recession fears, inflation pressures that force the Fed to resume interest rate tightening, or a geopolitical shock — such as a U.S.-Europe trade showdown could dent the enthusiasm for risk assets.

Not enough worthwhile risks to get you reconsidering lightening the load on stocks here? Then how about what may be a lackluster first quarter earnings season. Warnings from FedEx and Tiffany & Co. in recent weeks suggest as much, yet the market has stayed on autopilot.

But the bottom lines for Corporate America probably looked much different in the first quarter of 2019 than the fourth quarter of 2018.

Deutsche Bank points out that S&P 500 earnings are expected to have dropped 2.5% in the first quarter, down sharply from 15.5% growth in the fourth quarter. Declines are forecast in the energy, tech, financials, consumer discretionary and industrial sectors.

The outlook for profits isn’t anything to jump for joy over, either, despite the market’s suggestion to the contrary. Earnings for the S&P 500 are expected to be flat in the second quarter, rise 1.3% in the fourth quarter and then pop to 8.1% in the fourth quarter.

Yet, the out-sized bullishness on the Street persists.

“We would be careful not to extrapolate too much from the quarter over quarter earnings results and also year over year like comparisons for 1Q19,” said Jefferies strategist Sean Darby.

Market complacency is worrisome

Complacency is a bad thing in life. As soon as you think you have it all figured out — boom — life roundhouse kicks you in the jaw. More often than not you deserve that roundhouse kick for not staying appreciative of what could go wrong... and safeguarding accordingly. Complacency in investing is also a bad thing. One day you are sitting on a 20% gain on a stock, the next its down 25% in a session following an out-of-the-blue earnings miss.

But is it really out of the blue? Not really — you just got complacent.

“Yes, a lot is already priced in and the market is arguably due for a modest selloff,” said Deutsche Bank chief U.S. equity strategist Binky Chadha. “It has been 3½ months since the last selloff, while the market typically sees modest 3%-5% sell-offs every 2-3 months. This rally is already in the top one-fifth by duration and the chances of a pullback increase the longer it goes.”

The team at BlackRock concludes, “We see scope for the risk rally to persist in the near term, but are wary of market complacency and the potential for volatility.”

You have been warned.

Brian Sozzi is an editor-at-large at Yahoo Finance. Follow him on Twitter @BrianSozzi

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