Pisani: Is the retail investor getting back in right near the top?

Just back from a Thanksgiving vacation, and I couldn’t help but be amazed at watching the market inch to historic highs — twice — in a week!

But I haven’t changed my opinion: The market is advancing on thin ice. There are several reasons I’m suspicious.

  1. Investor sentiment has switched dramatically, from outright skeptical to bullish. That’s not a good sign, particularly when you see it happening among retail investors. At the end of last week, the AAI Investor Survey — a widely watched indicator of retail investor interest in the stock market — spiked to 49.9 percent bullish, from 23 percent bullish the week before the election. It was the highest reading in nearly two years.
    – Big spikes in retail investor sentiment have traditionally been associated with at least short-term tops in the market.
    – But even professional investors are getting notably more bullish. Investors Intelligence, which each week surveys roughly 140 newsletter writers, showed Bulls at 55.9 percent, the highest since late August.
    – The Merrill Lynch Global Fund Manager Survey, a survey of 177 fund managers the week after the election, showed that 35 percent expect the global economy to improve next year, the highest levels in 12 months. Cash levels, which were at 5.8 percent in October, have dropped to 5 percent, the largest month-over-month drop since August 2009.
    – In my experience, these sentiment and survey indicators are only useful at extreme readings, where they are generally used as contrarian indicators.
    – One of the best things the stock market has had going for it in the past few years is the outright skepticism and hostility to any and all rallies. That is now ending.
  2. The markets are due for a pause. Investors have been pouring money into stock ETFs and out of bond ETFs — great news for retail brokerage firms, but Is the retail investor getting back in right at the top?
    – Look at these moves since the election:
    – Russell 2000: Up 13 percent
    – S&P 500: Up 3.8 percent
    – 10 Year Treasuries: Down 3 percent
    – Here’s what I see: Going long stocks and short bonds is far less attractive now than it was a month ago.
  3. The rally is pricing in a near-perfect environment, but there’s lots of things that could go wrong:
    a) Dollar strength, if it continues, could be a big problem for multinationals who export, as well as for emerging markets like China.
    b) Markets are still pricing in a very accommodative Fed, but any indication of a more aggressive stance — quite possible if GDP growth trends toward 3 percent and inflation picks up — is not priced into the market.
    c) Any move to aggressively translate Trump’s trade war rhetoric into reality will be a problem. If we know anything from history, it’s that heavy tariffs and trade wars are bad for markets.
    d) Lengthy delays are likely in enacting any stimulus or infrastructure spending plans, tax cuts, and particularly reduction in regulations. All three of these are, for the most part, late-2017 and 2018 events.

The market is already showing signs of slowing down. To begin with, the rally last week was on declining volume. Volume was strong in the first two weeks, but the buying interest began petering out last week. We rallied largely because sellers did not want to part with stocks, not that buyers were still enthusiastic.

Some sectors are already looking toppy. Pharmaceutical stocks, which rallied in the initial days after the election on hopes of reduced regulation, have been on a clear downward descent in the past two weeks.

Bank stocks, which have seen the most notable rallies, have moved mostly sideways in the past week.

Same with bond yields … the big rise occurred in the two weeks after the election and beginning last week 10-year yields