A nagging doubt below the market's ebullient surface

U.S. equities chopped around the unchanged line on Tuesday amid volatile trading -- something traders haven’t really experienced since the post-election “melt-up” started in early November. Political machinations in Washington were the main event, as President-elect Donald Trump’s cabinet picks move through the Senate, while the House considers what to do about Obamacare.

The big economic headline was the explosion in small business optimism, posting the biggest monthly gain on record in the aftermath of Mr. Trump’s surprise win.

Yet while the perceived economic tailwinds are great and everyone seems excited about the future, something is keeping a cap on those animal spirits.

Market breadth, for one thing, remains a problem as buying interest in stocks narrows. Investor expectations may have come too far too fast, leaving the market vulnerable to disappointment heading into the inauguration as the post-election honeymoon gives way to the realities of governance and setting policy.

In fact, as noted by Jason Goepfert at SentimenTrader, breadth has narrowed to such a degree that Monday marked only the third time since at least 1984 that the Nasdaq composite index closed at a new high even though more issues declined than advanced.

That also happened in July 1998 and February 2012. Both times, stocks declined almost immediately afterward.

In 1998, the index went on to lose a quarter of its value in the months that followed as Federal Reserve interest rate hikes destabilized foreign currency and bond markets. That’s somewhat similar to what’s happening now as the surge in the U.S. dollar and interest rates since the election has unnerved markets from China to Mexico.

In 2012, the Nasdaq recovered from a short-lived pullback to hit new highs before rolling over and losing 12 percent over the next couple of months.

It’s not just the Nasdaq that’s suffering from narrow breadth. The 20-day moving average of the New York Stock Exchange advance-decline line has rolled over to levels not seen since late November. It’s down 75 percent from the highs seen in early December. 

The NYSE up volume ratio has been below 45 percent for the past three days, while stocks overall have barely budged. That has happened only one other time in the last 50 years (January 1970).

Seasonality is also shifting negative as Wall Street exits the “Santa Claus” tailwind and hits the headwinds stocks have faced in the second half of January in recent years. Not only that, but investors will need to contend with the start of the fourth-quarter earnings season in two weeks.

That’s a lot to chew through, so it’s no surprise that economic uncertainty has reached its highest level in years according to a media-based index created by economists from Stanford, the University of Chicago and Northwestern that uses mentions of uncertainty in major newspapers.

Yet market-based measures of confidence -- from equities to bonds and the CBOE Volatility Index (VIX) -- remain ebullient. Consumers are demonstrating a similar disconnect, with survey-based measures of confidence surging, while retail sales over the holiday shopping season were rather tepid based on early indications.

Business owners also appear a bit split, with small-business confidence off the charts but actual spending down and hiring plans weak.

To put it plainly, a lot of hope and optimism are out there as the prospect of “America first” nationalism mixed with tax cuts and deregulation seem poised to accelerate GDP growth and job creation. But that disconnect, a nagging doubt, is keeping shoppers, many investors (given narrowing breadth), the media and businesses more cautious than they’ll admit.

The tension can best be seen in the market’s inability to cross the Dow 20,000 threshold over the last five weeks despite daily cheerleading in the financial press.

Something has to give soon.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.