Time for a market breather?

Since the market’s rebound from the choppiness of last summer, the stock market is up about +25%! That’s great news for all of us. However, the question we now hear many of our clients inquiring about is “Where does the market go from here?” As in the case with most financial professionals, we think the answer is up as we believe that 2011 will be a good year for the market. But, we are expecting some consolidation (or pause in the current uptrend) over the next few weeks. The tone of the market has gone from concern last summer to some complacency today. As a result of our expectation for a short-term pullback in the market, we are sitting on all cash that has been recently deposited. Below are a few key reasons for our concerns:

1) Institutional investors are too bullish. A survey by Investor Intelligence of institutional investors currently has the percent bearish at 19% and those that are bullish at 57%. The bullish percentage is at its highest level since October of 2007. The spread of bullish investors over bearish investors (57%-19%= 38%) has only been recently this high in April of last year and October 2007. For us, this is a bearish indicator as the crowd now thinks the stock market is the place to be.

2) Individual investors are bullish as well (but not as bullish) with 52% of the American Association of Individual Investors (AAII) members bullish compared to the historical average of 39%.

3) The Volatility Index (VIX) has fallen dramatically from its May high of 48 to its close of 15.46 this past Friday, which highlights the complacency mentioned previously. The last time the VIX was at these levels was in June of 2007.

4) From a technical aspect, the stock market is overbought with the Relative Strength Index reading currently at 77. A reading above 70 indicates the market may be due for a short term correction and has been at these levels for 3 to 4 weeks.

Importantly, we believe that the long-term trend of an up market is still intact. However, the market’s frothiness needs to be worked off for the market to be able to march forward again. The market will take one of two paths to arrive at that point: 1) The market falls in value, or 2) the market remains in a trading range for a few weeks. With this perspective, we think it makes more sense to be cautious with your cash until the overbought conditions are alleviated.

Sincerely,

Your THOR Team