The stock market feels long overdue for a pause

Up five days in a row for the Dow Industrials, and today seems like a good day to do it. Inflation topping 10% in the U.K. is weighing on Europe, but not by much: most European indexes are down about 0.5%. Pisani’s 25th Law of Broadcast Journalism says, “You know you’re in trouble when your best sources call and ask YOU what’s going on.” I’ve been getting those kinds of questions lately. “Why do we keep going up, Bob?” You might call it a seller’s strike. For the last two days, traders have tried to sell stocks right after the open, and two days in a row, even with seasonally light volume, the market lifts. Why? One partial answer is that momentum is so strong there is a bit of a seller’s strike going on. Who wants to sell stocks when the trend is up? It doesn’t help that it looks like the hedge funds are being dragged in. I explained this yesterday: if you’re a hedge fund that is normally, say, 4% in cash, and you panicked in the second quarter and went to, say, 20% cash, and the S & P has now risen 14% in the third quarter, you are likely very nervous because you are probably underperforming the market and are being forced back in, whether the market is expensive or not. Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, who tracks short selling, made the same point yesterday. “The size and breadth of the recent market rally seems to be more than retail buying could support on its own and suggests larger institutional (hedge fund) activity, so we may be seeing the smart money getting into the market in size,” he said. “After missing out on a good portion of this second half rally, institutions may be starting to increase their market exposure in order to make up for the returns they already missed…We may be seeing a case of institutional FOMO [Fear of Missing Out] and institutional dollars joining the existing retail buy-side pressure driving up stock prices.” You might also call this “bearish capitulation.” Remember two months ago, when everyone was predicting an imminent summer swoon, when the market would drop an additional, say, 10%, and everyone was talking about the S & P 500 at 3200-3400? Wrong! The S & P just passed 4,300. So instead of wondering whether the market will hit new lows, bears are back to wondering what kind of (modest) pullback we should see. The bulls have a different problem: with this big runup the market is pricing in a perfect scenario. The economy has to be strong enough to stave off anything but a mild recession, and inflation has to show signs it is abating. Market rally or not, there are plenty of people who think that is a tall order. “While our baseline (modal) forecast sees the global economy narrowly avoiding recession, we judge that the risks are skewed heavily to the downside,” Nathan Sheets at Citi said in a note to clients this morning. “These include a sharper-than-projected downturn in the euro area, a failure of the Chinese authorities to provide sufficient stimulus, and a more rapid softening in U.S. consumer spending and labor market conditions.”