When Will This Big Pullback Finally Happen?
CNBC.com Senior Writer
That stock market retreat that everyone has been waiting for should be along...well, any day now.
Most of the conditions needed for a pullback are in place: Substantially overbought stocks, a protracted period of low volatility and the presence of multiple headline scares just to name a few.
Truth is, though, that the pullback likely will come in its own good time, with little warning to prepare those who have piled more than $40 billion into the market since the beginning of 2013.
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"The important thing to recognize is that once the market gets as hideously overbought and overenthusiastic and euphorically bullish as this market has been, you don't need a catalyst," said Walter Zimmerman, senior technical analyst at United-ICAP. "Once the exuberance has exhausted itself it falls of its own weight because it's been so overcooked."
While his adjectives may go a bit far in describing the current market mood, there's no doubt that the sentiment is strongly bullish even if recent surveys show optimism dimming a shade.
More tellingly, stocks are demonstrably overbought, with at least three-quarters of the Standard & Poor's 500 trading well above their 50-day moving averages. The index itself is 3.6 percent above its 50-day average and 8.1 percent ahead of its 200-day moving average.
If that's not enough, there's an extreme level of complacency, as measured by the CBOE Volatility Index, a gauge of fear that is just above 13 even after a 7 percent mid-day rise Wednesday. History says that when the market goes 20 days without having at least three sessions showing 1 percent intraday volatility, a pullback of 5 percent or more is in the cards. The trend has held up for every pullback since the bull market began in 2009, according to S&P Capital IQ.
While the market certainly can continue to climb under such conditions, history suggests a retreat—though probably not the full 10 percent that would constitute an official correction—is most often coming. The Federal Reserve's $3 trillion liquidity pump has helped keep a floor beneath stock prices since the rally began off the March 2009 lows.
"I don't know exactly when this decline will start, nor can I tell you precisely how far the market will ultimately fall," Sam Stovall, chief equity strategist at S&P, said in a report. "However, based on comparisons with prior market tops, I believe the decline will be the kind that is refreshing, healthy, or even a bit scary, but not overly damaging to one's portfolio in either time or magnitude."
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The damage such a pullback would cause could end up depending on technical factors.
Zimmerman said the S&P 500 would have to fall all the way to the 1,415 level of last June - a 7 percent tumble - to do any real chart damage that could precipitate a harder decline.
Still, retail investors might want to take heed that a little patience could pay off here.
"If you're a long-term investor now would not be a good time to be buying stocks, but if you're a trader it could still be a good time," said Phil Silverman, partner at Kingsview Capital. "If you look over a full cycle of the market, the valuations aren't that attractive."
Those looking for a catalyst could find many, Silverman said.
They include the upcoming mandatory spending cuts, known as sequestration, that will kick in at the end of the month unless Congress acts. They also include some serious challenges for consumers in the face of $4 a gallon gas and increasing taxes that could slow spending and hurt corporate earnings.
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"The combination of all this in the system is going to continue to stop the economy from growing the way it could be growing," Silverman said.
Corporate profits also will be squeezed by increasing pay levels. Labor costs now comprise 4.9 percent of total corporate income, according to the Bureau of Labor Statistics.
"We suspect that cyclical forces will prompt a further rise in workers' slice of the US economic pie this year, and that the resulting squeeze on profit margins will weigh on the stock market," said John Higgins, senior market economist at Capital Economics.
Capital expects the S&P to swell to 1,550 in the second quarter then snap back through the year to end at about 1,500 - still representative of a full-year gain but down modestly from current levels.
"When a bull market is in its exuberant stage it ignores all kinds of bearish news," Zimmerman said. "There's definitely room for a bull-market correction."