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'Buy the dip' works again for a bull market that just won't quit

Despite the market dodging one bullet after another, investors by at least one account are more worried than they've been all year.

Yet a legitimate argument for a substantial downturn in stocks that could turn into a bear market is getting harder and harder to make.

Not that many aren't trying: Worries about economic growth that could turn out weaker than expected, central bankers putting the screws to monetary policy and valuations getting out of whack are just three arguments against the market.

But none of them seem to be sticking.

Jonathan Golub, chief equity strategist at RBC Capital Markets, took a stab at it in a note sent to clients Monday morning. He laid out four fairly common bearish arguments these days, but concluded that they are "increasingly contrived":

  • 1. Purchase Managers Indexes "rolling over." The PMIs are closely watched gauges of manufacturing activity that show the percent of companies expanding, and they've been weakening lately. The most recent reading for April was 54.8, the lowest of the year. However, Golub said history shows that as long as the reading stays above 52, that's positive for stocks. (A reading below 50 indicates contraction.)
  • 2. The debate between soft data and hard data has been ongoing through the year. The former consists of sentiment gauges while the later indicates actual activity. Hard data have been lagging high levels of soft data, but Golub says that's not unusual: "They're designed specifically to lead the hard data."
  • 3. Valuations: At 17.3 times earnings, S&P 500 stocks are priced above normal. Golub says that as long as the U.S. economy avoids recession, elevated valuation shouldn't be a problem.
  • 4. Perhaps the most important is the Trump trade. Stocks have been in rally mode since Donald Trump's win in November's presidential election. Therefore, some fear, an inability to get his pro-growth agenda through Congress will spell doom. However, Golub points out that most of the Trump trade has eroded anyway — the dollar has weakened, financial stocks in particular have stalled and some of the biggest gainers have been defensive rather than cyclical names.

"This leads us to believe that the market is discounting very little in the way of policy changes, making stocks less vulnerable if they don't occur," he said.

Waiting for the dip, coming up empty

Investors have been waiting all year for a significant downturn but have yet to see one. Last Wednesday's sell-off was the worst of the year and sent major averages down around 2 percent, but it didn't last long.

Stocks were in rally mode again Monday, and the S&P 500 is up 6.7 percent year to date. Tech names have gained even more with the Nasdaq up more than 13 percent.

Still, there's plenty of fear to go around in the market.

The most recent survey from the American Association of Individual Investors found bullishness at its lowest level of the year — 23.9 percent to 34.3 percent on the side of the bears, or those who think the market will be lower in six months.

Tellingly, neutral sentiment spiked to 41.9 percent, which is well above the long-run average of 31 percent and indicative of a general ambivalence among the retail crowd.

Wall Street NYSE
Michael Nagle | Bloomberg | Getty Images

Generally speaking, complacency is the market's friend until it isn't anymore — neutral sentiment will drive the market higher but then converge against it when investors are given a legitimate reason to sell.

"We're entering the season during the summer when people like to take back risk," said Doug Roberts at Channel Capital Research. "That could cause more of this churning action that we're seeing right now for the next couple of months."

At this point, it appears that the bearish position won't come from any of the usual suspects but rather something unforeseen.

"While it is impossible to predict black swan events, there are a number of risks that we believe are noteworthy," Golub conceded. "On the top of the list is a rollover in the Chinese economy. Over the last year, a pickup in Chinese activity has contributed to the economic improvements described earlier. Should this falter, we would expect a disappointment in both the economic data and earnings."

Black swans and trade wars

There are others as well.

Roberts believes some type of blow-up on the world stage would be needed to knock the market off course — South Korea firing a nuclear weapon, or Trump facing actual impeachment proceedings, to name two.

"What I'd be looking for is not so much a smoking gun, I'd be looking for a geopolitical event ... a black swan somewhere, a trade war, an event with Korea," Roberts said.

Fitch Ratings also cited a trade war as a significant danger, even though Trump has softened his isolationist talk lately.

"A hypothetical trade war would lead to adverse outcomes in all major economies," Brian Coulton, chief economist at Fitch, said in a statement.

Finally, companies are just wrapping up a stellar earnings season that saw profits rise nearly 14 percent, but Nick Raich, CEO of the Earnings Scout, believes the rest of the year won't match up. Raich believes investors should be cautious — still invested, with a reduction in exposure for U.S. stocks to global equities.

"We do not believe stocks have ballooned into a bubble as many think," Raich said in a note Monday. "Nor are we recommending for you to be greedy."

Correction: The Nasdaq is up more more than 13 percent year to date. An earlier version misstated the percentage.