Bullishness on stocks sure paid off in 2010 as the market put up strong double-digit returns, but investors would be wise to recall that equities didn't turn positive for the year until its last few months. If 2011 really is shaping up to be a reprise of 2010, the market is poised for a fall.
Remember that after topping out in late April, stocks went into a swoon that didn't bottom out until July, slicing 17% off the S&P 500 ($INX) along the way. Jeffrey Saut, chief investment strategist at Raymond James, has been timing the market as well as anyone over the last couple of years, so when this bull turns cautious, we'd best heed his warnings. And right now Saut sees things lining up in a way that's spookily similar to 2010's trend.
"I am worried that last January's stock market pattern may be repeated this year," Saut told clients in his inaugural report of the new year. "While markets can certainly do anything (read: can continue to travel higher), the odds are not tipped in investors' favor in the short-term and I am cautious."
Take a look at this chart of the Dow Jones Industrial Average ($INDU) and S&P 500 from January 2010. Both averages got off to good starts, tacking on a decent 1.5% or so through the first three weeks of the month. Then they tanked. By January's end the Dow was off nearly 5%, and the broader S&P 500 was down more than 5%.
Never mind the macroeconomic and geopolitical risks that could derail the rally. Even if you're bullish on stocks for the year as a whole, too many technical indicators are lining up that suggest a pullback or correction is due, Saut writes.
For one thing, investors are way too complacent. The CBOE Volatility Index ($VIX), also known as the "investor fear gauge," is down to levels last seen in April 2010 -- right before the market went into that 17% correction that lasted until July, Saut notes. When investors get too comfortable (believing that the market can only go up), well, that's when bad things can happen.
The same goes for sentiment, which is also a contrary indicator. When investors reach levels of extreme pessimism, all the sellers have already sold, meaning stocks are poised to rise again (the thinking goes). The converse is also true: When everyone is wildly bullish, all the buyers have already bought.
So consider this: Investors Intelligence data indicate advisers are approaching the bullish extremes of October 2007, Saut writes. That's when the Dow peaked at its all-time high above 14,000.
Plenty of other technicals are flashing yellow, too, the strategist says. "Stock market leadership is narrowing, internal momentum is waning and every macro sector except utilities is overbought," Saut writes. "All of this suggests more caution is warranted as we enter the new year."
Understanding Stock Market Indexes
What does it mean when people say "the market is up 2%"?View Course »