U.S. stocks correction fear fades despite valuation angst

Mon Feb 17, 2014 7:01am EST
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By Ryan Vlastelica

(Reuters) - A rapid recovery in U.S. stock prices after the recent slide may be enough to make many investors who remained bullish feel a little smug. That would be a mistake, market strategists say.

Investors should instead take the emerging markets scare that drove stocks down about 6 percent at the end of January as a warning of more risks to come. Things have changed from 2013, they stress, and this is no longer a market that will lift all boats indiscriminately. So playing some defense is appropriate.

Cantor Fitzgerald, for one, said it was considering new hedges at these levels. Peter Cecchini, global head of equity derivatives in New York, said markets would be "far more sensitive to bad news" in the current environment, which "presents a new volatility paradigm in which risk management will be rewarded rather than punished."

With few obvious justifications for stocks climbing further, investors are left in the position they were in at the beginning of the year: unsure about the economy and earnings, but facing an environment where few other assets offer the same potential return as the equity market.

Despite the rebound in the past two weeks that has taken the S&P 500 .SPX to within 0.5 percent of its all-time closing high, investors have been more circumspect in their approach. Trading volume on down days has far outpaced the action in positive sessions, indicating traders are more eager to unload shares than chase gains.

Investment flows have followed a comparable pattern, according to Lipper's fund-tracking data. Investors returned money to equity funds in the latest week, adding nearly $6.9 billion in the period ended February 12, but that pales in comparison to the more than $22 billion yanked from stock funds over the previous two weeks.

In another bearish sign, margin debt hit its fourth straight monthly record in December at $444.93 billion, according to Thomson Reuters data, a factor that has historically preceded market pullbacks, including shortly before the pre-financial crisis top in July 2007.

Increased debt creates the potential for margin calls, which occur when securities purchased with borrowed money fall below a certain value, forcing the investor to sell assets.   Continued...

Traders use a paper trading slip on the floor of the New York Stock Exchange February 13, 2014. REUTERS/Brendan McDermid