Managing Expectations

The markets are confounding bears and bulls alike. Stocks are at record highs, but the correction many investors are expecting may not be as bad as they fear.

With stocks at record highs and investors unconvinced that the milestone is deserved, the throngs looking to "sell in May and go away" seemed raring to go…in April.

That impulse is particularly strong this spring. In each of the past three years, U.S. stocks peaked in April and then corrected 10% to 19%. The Dow Jones Industrial Average has just snagged its best first quarter in 15 years, and the Standard & Poor's 500 has levitated 23% since June. Even optimists must wonder if this rally is due for a pause.

Yet if markets exist to confound the most number of people, this year's spring break may last just long enough to bother the bulls, but stay shallow enough to annoy the bears. After all, the 2010 spring was consumed with the European debt crisis. A year later, the Arab Spring sent oil prices soaring while the U.S. put on quite a show of squandering its triple-A credit rating. Last year, Europe's recession was complicated by fears of a Chinese hard landing and U.S. political uncertainty. Today, the planet's problems haven't been resolved, but many of the macro-economic risks have at least receded.

Jeffrey Kleintop, LPL Financial's chief market strategist, thinks the odds of a fourth consecutive spring correction are small, but a minor 5% pullback is likely. Consumer confidence is declining, and a subdued volatility is evidence of complacency. But five of the 10 cues he's watching -- like central-bank stimuli, energy prices, current economic and market conditions, jobless claims, and inflation expectations -- continue to support stocks.

Yet the market remains antsy. The year's leading sectors -- health care, up 15%, and consumer staples, up 14% -- both are defensive.

Individuals and pensions also remain underinvested in stocks. Barry Ritholtz, CEO of Fusion IQ, calls this "the most hated rally in Wall Street history." Even as stocks climbed, "many participants are unable to pry their eyes from the wreckage in the rear-view mirror." Our central bank's wilful manipulation of economic cycles has subverted order. Today, thinking investors are wary, and bears outraged.

The result is a roundly disliked market that's "under-owned by investors, not unreasonably priced, with few alternatives to equities," Ritholtz says. "Does that sound like the recipe for a market crash to you?" 

Source:  Kopin Tan, Barrons

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