In the first 11 months of this year, key stock indices like the S&P 500 have gone up 26%. But as this happened, we saw optimism towards stocks increase and fundamentals became weak—two major negatives for stocks going into 2014.
According to the Investment Company Institute (ICI), U.S. long-term stock mutual funds have been witnessing massive inflows. Between the week ended October 23, 2013 and the week ended November 20, 2013, U.S. long-term stock mutual funds saw inflows of $23.95 billion. (Source: Investment Company Institute, November 27, 2013.)
It seems investors are confident key stock indices will continue to go higher. Risk is not a concern anymore. One of the ways this can be seen is via the Chicago Board Options Exchange (CBOE) Market Volatility Index—better known as the “VIX.” This index gauges the amount of fear in the key stock indices. You will see in the chart below how the VIX is breaking down to new lows.
Chart courtesy of www.StockCharts.com
The VIX is saying investors are far from worried about a decline in key stock indices. But the optimism doesn’t end here; I’ve read several analysts say key stock indices will soar higher. One of the most recent examples is Adam Parker from Morgan Stanley (NYSE/MS). He believes that the S&P 500 (currently at 1,800) will reach 2,014 by the end of next year. (Source: Wall Street Journal, December 2, 2013.)
On the fundamental side, the most critical factor for a rally in key stock indices—corporate revenue and earnings growth—just isn’t there. Consider this: as of November 29, almost all of the companies in the S&P 500 have reported their corporate earnings for the third quarter of 2013. We found little more than half of the companies on the S&P 500 were able to beat revenues forecasted by analysts. (Source: FactSet, November 29, 2013.)
Does all this mean we have formed a top in key stock indices? Dear reader, we can say a market is overpriced and due for a correction. We can see the fundamentals behind the market just don’t make sense anymore. But we always have to remember that irrationality can go on for longer than most expect. But in all cases, regression to the mean does follow…and often when it’s least expected.