Santoli: Stocks have been in a 'quiet correction' for months

• Stocks have been in a funk for about two months, with the majority of stocks sagging far more than the indexes since mid-February.
• Several indicators - the jumpy VIX, wider corporate-bond spreads and heavy options hedging - reflect a slowly building wall of worry.
• Some traders now want to see signs of greater panic and more oversold conditions to make for an ideal buying opportunity.

The market has been caught in a quiet correction for nearly two months, its once-hot sectors now well chilled and investor ebullience coming off the boil. The question now is how it ends – with a whimper or a bang.

Since the all-time intraday high of 2,400 on March 1 – the day after President Donald Trump made his crowd-comforting speech to Congress – the index is off only about 2 percent, and at its late-March low was down a modest 3.2 percent.

Yet by last week, nearly half of all stocks in the broad S&P 1500 were down at least 10 percent from their 52-week high, the popular bank sector remains down that much and economically attuned groups such as transportation and steel have lagged badly.

The market's behaved like a football team that keeps punting on fourth-down short-yardage situations, confident that its defense can hold off the other team until the offense gets in gear. So far, the bulls have given up plenty of yards but not all that many points, thanks to strength in utilities, consumer staples, and mega-cap tech and other growth stocks.

Since around the time of the market high, the 10-year Treasury yield has ebbed to 2.2 percent from 2.6 percent, the CBOE S&P 500 Volatility Index (VIX) has climbed into the mid-teens from around 11 and the Atlanta Fed's GDPNow forecast model for first-quarter growth has tumbled to 0.5 percent from 2.5 percent. Investor attitudes have also run from excessive bullishness to a warier outlook, with weekly investment-advisor polls, the CNNMoney Fear & Greed Index and the Bank of America Merrill Lynch Global Fund Manager Survey suggesting that the so-called wall of worry is gradually being rebuilt.

This subtle but noteworthy change in market character means we're again at a point where market handicappers are asking whether the market's internal weakness has been dramatic enough, with enough "oversold" conditions popping up, to set up a strong rebound. So far, according to close students of tactical market clues, the answer is "Close, but not quite."

Katie Stockton, technical strategist at BTIG, says last Thursday's high-volume sell-off sent some of her preferred indicators to extreme readings that often set up a good rebound. Yet, she concludes that "down-volume was strong enough to suggest the pullback still has a hold on the market." Confident that the longer-term market uptrend remains intact, she says, "We remain on the lookout for a buying opportunity, which appears more likely after a shakeout in high-beta areas of the market."

Similarly, BAML's Stephen Suttmeier sees this little downside reset in the market as incomplete. One notable shift is the arrangement of the short-term and longer-term VIX futures prices, with immediate volatility expectations appearing puffed-up relative to more distant ones. Without getting into the statistical weeds, it's another "oversold" condition, one that says traders are paying up aggressively for a possible sudden spike in market risk, despite the still-placid behavior of the indexes themselves.

While this is a start, Suttmeier argues that broader measures of downside hedging with options "are nowhere near the oversold levels that have coincided with important S&P 500 lows." He figures the index has another 2 to 4 percent of risk to the downside in the fairly near future based on the weight of the evidence.

Of course, we don't always get the textbook setup or the classic flush of panic before the indexes regain their footing. There are some resemblances between the recent action and what occurred in August and September of last year and ahead of the U.S. election: a gradual welling up of anxiety, lots of money spent on hedging equities through volatility derivatives even as the market was moving only grudgingly lower.

The quirk this time is that when the VIX makes a five-month high (as it did in recent days), the S&P 500 is usually down a whole lot more than 2 or 3 percent from an all-time high. Does this mean traders are overreacting to modest weakness, or are the options guys foretelling a stormier period ahead? Worth watching is the corporate-credit market: It remains firm, but risk spreads have modestly widened in recent weeks, slightly weakening one of the stock market's key sources of strength in the past year.

Even the strongest years tend to have one or more declines of more than 5 percent from a high, so this would be consistent with the rhythm of an ongoing market advance – one that is strongly suggested, based on historical patterns, by the impressive start to the year. If the late-March lows were as deep as this quiet correction gets, it might be comforting, but it also likely means the market won't have built up sufficient fear or reloaded with enough fresh buying power to vault the market too quickly on a powerful new leg higher. This is often the trade-off traders face – muted volatility can contain the market in both directions for long stretches of time.

Earnings season tends to be noisy, with lots of offsetting moves, but so far the results are supporting the view for a decent rebound in profits for this year. It's fairly telling that most of the cautious strategists expect little more than a retreat of a few percent or so from here, which most would view as a decent buying opportunity. Perhaps too many are hoping for a dip to buy that either we won't get one, or it will threaten to build into something that feels much more hazardous than an innocent little setback?