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No shelter for U.S. stocks as trapped global investors flail

Michael Santoli
Michael Santoli

If the Dow is poised to recover, aren’t the obliterated emerging-market stocks a Buy?

Anyone who thinks the tech sector has been punished enough should be tempted to buy South Korean stocks as much as the Nasdaq, right?

And if you think the flight from risk since late summer has just about run its course, wouldn’t the junk bond index at a 7.7% yield offer more comfort than the S&P 500, which still isn’t exactly cheap?

If you answered “No” to these questions – perhaps because those more exotic sectors look to be in scary liquidation mode – then you have a sense of the bind the U.S. stock market is in.

Unceasing pressure is being applied across so many global markets that the headline asset class captured by the Dow and S&P has been unable to find its footing.

It’s not just about relative value, with other stuff getting cheaper and leaving big American equities in a less flattering light.

There’s also a feeling of scared, trapped capital struggling to escape, whether from the most speculative-grade corporate bonds, or distressed commodity poster child Glencore plc, or from any market that a cash-strapped Saudi Arabia just called its money back from.

Investors here have done their best to stay sheltered in sectors most reliant on American consumer spending and category-dominant growth names. But they’ve been smoked out of many hiding places by now.

With the biotech crunch of last week, the healthcare group, as tracked by the Health Care Select Sector SPDR (XLV), is now down for the year. Healthcare has been a multi-year leader, a growth-value-demographics-merger bullish thesis in one package.

This leaves only the consumer discretionary sector up slightly for 2015, thanks mostly to retailers and consumer durables stocks.

Do all the “safe” hiding places need to be exposed for the market to finally get that flush of surrender that so many seem to be watching for?

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If not surrender, investors have remained steadily in retreat for weeks, driving most of the typical measures of public mood toward anxious extremes that often allow for a decent rally.

This contrarian logic hasn’t worked too well in recent weeks, hinting that the market is redefining what “extreme sentiment” means in a deep correction versus the dip-buying environment of the past few years.

This bull market had already flattened out in the year preceding the tumble into the correction in July, which has undercut the longer-term view of the trend.

The twelve-month average level of the S&P 500 has dropped for two straight months, something that has only happened twice since 1995 – both as bear markets got underway.

While the current valuation of the stock market is unchallenging around 15-times forecast corporate earnings – assuming those forecasts are roughly right – the nasty setback in corporate credit keeps stocks from appearing reliably cheap.

[While not a magic indicator, the free cash flow yield of S&P 500 companies is less than 5%, while junk debt yields 7.7%. This bull market has done its best work when free cash flow yields exceeded junk yields.]

So many people are assuming the S&P 500 must at least “re-test” its August low of 1867, down more than 3% from here, it might be tempting to take the other side.

Plenty more are using the 2011 panic as a guide, which would mean a drop below 1750. Now that we have Congressional dysfunction and a threatened debt-ceiling standoff on the radar, maybe traders are over-extrapolating the similarities.

Even if it’s hard to play the hero and bet on the world not ending soon by buying emerging-market stocks or junk bonds, those are the sectors at least to watch for clues about when the Dow might make an important stand.

The U.S. stock market, at the moment, can not heal itself.