The S&P 500 edge up a fraction of one percent last week on extremely low volume, which was in part due to the Labor Day holiday. Volatility crept up very slightly, as it continue to hover near historically very low levels.
So the S&P has once again bounced back from a minor sell-off to regain not only all the prior losses, but to set another new high, slightly above the previous high. In terms of technicals, the equity market has once again returned to an extremely overbought state, both on the daily and weekly resolutions. Interestingly, however, another risk asset market—high yield debt—never regained its former highs. What’s worse, over the last two weeks, HYG has resumed the downturn that first began in July. Will credit lead equities again this time?
In the world of macro news, last week’s announcements were very mixed. On the positive side, both ISM manufacturing and ISM services handily beat expectations. Our trade deficit was also not as bad as feared. And construction spending came in better than estimated. On the negative side, factory orders—when removing the volatile aircraft orders—fell by almost 1%. Jobless claims were worse than expected. The big number of the week, August payrolls, was disaster. Instead of the 230,000 new jobs expected, only 142,000 jobs were created. And to add insult to injury, the labor force participation rate slipped back down to multi-decade lows.
How did equity markets react to this dismal jobs report? They jumped higher on the perverse belief that bad news is good news because it will force the Fed to boost monetary stimulus which most everyone feels will just roll right back into stocks and push prices higher.
One person who is growing increasingly worried about the current run-up in stock prices is money manager John Hussman. In a recent note to investors, he attacks the notion that so many traders and investors in the US believe to be true—the notion that they will keep their money invested in stocks (Hey where else can you put it? Certainly not near zero yielding Treasuries, right?) until the markets turn down, and at that point, they’ll be among the first to “get out” and sell.
Why won’t most investors get out? The answer is that in equilibrium, they can’t. On any given trading day, only a fraction of 1% of total market capitalization changes hands, and the vast majority of that is high-frequency trading and portfolio reallocation between existing equity holders. Think about it – the only way for an investor to get out of stocks without someone else getting in is for the stock to be literally removed from the market. That source of net removal of stock is corporate repurchase activity, which recently hit a year-over-year pace of about $500 billion. That’s still less than 4% of total market cap in an entire year, and it’s a fairly good upper limit on the percentage of investors who will successfully get out of this bubble without the appearance of a miraculous multitude of greater fools at the very moment existing holders decide to sell.
So there you have it—simple numbers. Most owners, if they all chose to sell at once (which is exactly what happens in a panic) will not have any buyers of their stocks, at least at anywhere near the prices that they expected. Will there be any buyers at any price? Sure, but history shows that when prices have entered into bubble territory, and Hussman is forcefully arguing that this is the case today, then these buyers typically start to emerge only after prices have fallen by 30% and often by 50%.
In short, most investors are sitting on paper gains, and that when the selling starts—-and it has ALWAYS started in the past—that most investors will never be able to successfully retain these paper gains. They will get trapped.