How My Friend’s New Cadillac Suggests Stock Market Vulnerability in 2014

Stock Market Vulnerability in 2014Never mind the record breaks on Monday. The bulls are screaming “higher.” Dow 20,000, S&P 500 2,000, here we come. Wall Street is giddily raking up profits. There’s going to be some happy Wall Street workers when the year-end bonuses are announced.

One of my friends works at a major brokerage, and he just bought himself a brand new Cadillac “Escalade,” complete with the 22-inch wheels and every conceivable option. As my friend said, it was that kind of year when everything was going higher and the flow of capital into his accounts grew exponentially as his clients wanted big gains. The higher the stock market advance, the more money flowed into his accounts as clients chased returns.

Heck, he couldn’t even sell bonds as even his more conservative clients wanted more of the stock market action, rotating funds away from bonds and into equities.

The reality is that what’s happening at my friend’s brokerage is occurring everywhere. Not only with full-service brokers, but with DIY online discount trading accounts, too, which is why we have seen some big gains with the likes of The Charles Schwab Corporation (NYSE/SCHW), up 88% over 52 weeks, and E*TRADE Financial Corporation (NASDAQ/ETFC), up 118%.

And based on all the bullish investor sentiment, it looks as though, regardless of the rapid rise in the markets and valuations, investors still want to chase gains higher. My broker friend confirms this, as he noted that despite the amazing advance so far this year, money continues to flow in.

When I begin to hear that everyone is chasing the stock market higher, including the more conservative investors, alarms begin to ring in my ears. I heard the same thing in late 1999, prior to the Internet implosion in early 2000—these are the same bells that I’m hearing now.

Of course, the stock market could head higher prior to a stock market correction. Bond yields are relatively low compared to what we saw in 1999, so the alternative is not there now.

How high the stock market will rise is unclear, but the Federal Reserve’s apparent strategy to continue its easy money and low interest rates will help support the stock market.

I’m not going to say jump off. It may be the wrong call. Imagine those who were told to divest holdings at the end of 2012? They would have missed out on one of the best years for the stock market, so I really don’t want to be telling you to run for the exits now. What I will say is to walk slowly toward the exits. Take some profits off the table and cut some of your losing positions prior to year-end, as I still sense there is a stock market adjustment on the horizon. (Read “Nomura calls for 50% Correction in Global Stock Markets.”) You’ll also want to make sure you have some put options in place as a hedge.