Stock Market Keeps Going Up, But Skeptics Hold Tight to the Bear Case

(Bloomberg) — Climbing a wall of worry is one thing. Scaling the towering monolith of skepticism that currently comprises Wall Street’s view of markets takes uncommon courage.

Most Read from Bloomberg

The more the S&P 500 goes up — and it’s risen 6% in a month — the less people trust it. Hedge funds have been loading up bets against US stocks, with S&P 500 e-mini futures data showing near the most bearish reading since November 2011.

Mutual fund and futures-market outflows suggest that rather than rise, the index should have been down 3% over the past three months, according to a model kept by Goldman Sachs Group Inc.

“Being bullish today is a very lonely proposition,” said Eric Diton, president and managing director of the Wealth Alliance. He recalls being one of the only investors to raise his hand at a recent investment conference in Florida when asked if the stock market will gain 10% this year. “Everyone is negative.”

Sentiment is one thing, price action quite another. The VIX Index of volatility, now sitting below 17, is at its lowest since the start of last year. US corporate credit spreads, which closely track near-term expected market volatility, are showing “little concern about an impending slowdown in corporate profits,” according to Nicholas Colas, co-founder of DataTrek Research.

Among high-grade bonds, the extra yield over Treasuries paid to investors to compensate for credit risk stood at 134 basis points last week, the lowest since March 9 and below the one-year average. Among junk bonds it was 439 basis points, also the tightest since March 9.

“The corporate bond market is giving a similarly ‘all quiet’ message to the VIX’s 17.1 close on Friday,” Colas wrote in a note. “While we still think the VIX is too low (and stock prices therefore too elevated), it is not the only capital market saying the road ahead should be a clear one. Rightly or wrongly.”

Read more: A Signal Flashes That Was Bullish Last Nine Times: Taking Stock

Doubtfulness over the permanence of the market’s resilience has grown as stocks shrug off recessionary warnings and what’s expected to be two straight quarters of negative earnings growth. Equities keep rising, with the S&P notching weekly gains for the past five out of seven weeks.

S&P 500 returns tend to be positively correlated with flows, Goldman says. And when the two deviate, they tend to mean-revert later on. Data tracked by the bank show outflows have been strongest in mutual funds and futures, swaps and options. Their model suggests the index should be down 3% since Jan. 11. It’s actually up 5% since then.

“Flows have been weak,” wrote a Goldman team led by John Marshall. “This shows a lack of sponsorship for the recent equity rebound.”

Bets against the continued rise in stocks have been prevalent in the exchange-traded fund space, too. The Direxion Daily S&P 500 Bear 3X Shares (ticker SPXS), which tracks three times the inverse performance of the benchmark index each day, saw an inflow of $285 million on Thursday, a record amount. Meanwhile, the Direxion Daily S&P 500 Bull 3X Shares (SPXL), which seeks three times the daily returns of the gauge, saw a $274 million outflow, data compiled by Bloomberg show.

“There is a much larger downside risk to equities right now,” said Jake Jolly, head of investment analysis at BNY Mellon Investment Management.

There’s a hackneyed Wall Street adage: Sell in May and go away. Strategists have a more urgent warning these days: The time to get out is now.

“There’s no reason to wait — it’s not like you’re going to leave 10% upside on the table,” Troy Gayeski, chief market strategist at FS Investments, said on Bloomberg’s What Goes Up podcast. “The strongest rallies have always been in bear markets.” He sees a scenario where the S&P 500 could fall more than 20% from current levels.

Chris Harvey, head of equity strategy at Wells Fargo & Co., agrees that it’s not prudent to wait. He and his team expect a 10% correction in the next three to six months now that the S&P 500 is trading near their 4,200 target. If one were to assume that the Federal Reserve tightening cycle ended in March — which is still a coin toss, he says — then the relief rally is already reflected in stocks. But the tightening cycle may not be over and margin compression is “expected to outweigh a Fed pivot,” he wrote in a note.

“Two weeks ago, we highlighted the drop in yields and a perceived Fed pivot as the reason for resilience. Now everyone tells us everyone is bearish, so we need to be more bullish,” he wrote. The S&P has returned 7.5% year to date — a 30% annualized return — “and that’s plenty bullish for us.”

Hedge funds are betting that the good times won’t last. Large speculators saw their net short positions in S&P 500 e-mini futures increase to roughly 321,000 contracts as of the start of the month, according to data from the Commodity Futures Trading Commission. That’s the most bearish reading since November 2011 following the downgrade of the US’s sovereign credit rating.

“Short stocks is hard work right now,” wrote Brent Donnelly, president of Spectra markets.

But the idea that stocks should be rising once the Fed ceases its interest-rate hikes is misguided, according to Liz Ann Sonders, chief investment strategist at Charles Schwab. The final rate hike is usually not an all-clear signal for equities.

“Some of the problems, crises, and final whooshes lower in terms of the equity market have come after the pause,” she said. “There’s this misperception that the Fed either actually pausing or telegraphing a pause is sort of ‘full steam ahead, risk is in the rear-view mirror, back up the truck and load up on equities.’ Some of the problems come after the Fed has paused.”

–With assistance from Lu Wang, Isabelle Lee, Sam Potter and James Crombie.