Caution: Investor Optimism Running High Into 2014

stock market risksI am at best agnostic about technical analysis. I tend to believe that charts are like footprints: they show where you’ve been, not where you’re going. However, a major reason for my cautious 2014 stock market outlook can be summed up by this chart (courtesy of The Wall Street Journal):

Dow Jones_wsj, 2014 stock market outlook

Aside from the rather obvious triple top formation shown here we can see that the move up from the 2009 lows has been very nearly parabolic. Particularly the years 2012-13. In my long experience in the market, parabolic moves (up or down) are fragile and highly vulnerable to a retracement.

Another reason for caution is that sentiment has changed from overly bearish to overly bullish. James Stewart summed it up pretty well in a recent New York Times article:

In the many years I’ve been surveying experts for their predictions for the coming year, I cannot recall another time when optimism about the stock market, the economy and corporate profits was so widespread.

In other words, there is no room at all for disappointment. And this, despite by all measures, the holiday retail season was anemic at best and unemployment remains stubbornly high.

Karl Case, co-founder of the Case/Shiller S&P Housing Price Index was also quoted in the above referenced New York Times article, stating: “when everyone expects something to happen, that’s when it doesn’t”. There are just too many Bulls out there for my taste.

I am an options educator, ex-market-maker by trade so let me end this cautionary tale with an options related warning signal:  the CBOE Volatility Index (VIX).

The VIX has often been called the Fear Index because when markets are weak and people are frightened option premium, particularly put premium, is high. When the government shut down last fall the VIX went to the mid-twenties. And at the height of the financial panic in October 2008 it hit 80!

Well, I also see the VIX as a complacency index. When people are lackadaisical about the market and confident that the only direction is up, they tend to underinsure their stock portfolios. And that’s what I believe we are seeing right now. And this makes my 2014 stock market outlook cautious.

Even with a relatively weak start to 2014 the VIX is only at 13.55. This suggests to me a great deal of complacency. It does, however, provide you, Prudent Reader, an opportunity to buy cheap insurance even if you believe that the bull market still has a ways to run.

Remember, all things come to an end, markets revert to the mean and Black Swans do fly. With these notes of caution, I wish you and yours a safe, healthy, happy and prosperous 2014.  Note that you can also catch me on The Liss Report.

No positions in any of the mentioned securities at the time of publication.  Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.

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