It's not hard to see why people worry that this year's stock market is playing with last year's cookie cutter.
The parallels are striking. After an October selloff that some said was the death knell of the bull market, stocks moved up, recapturing the old highs and putting on a tremendous rally through the winter. After a springtime period of nervous consolidation and range-bound trading, the beginning of summer brought on another big rally -- this despite lots of squeals about how valuations were
too high. In the meantime, complacency was also running high. In the options arena, for example, implied volatility -- a measure of how volatile the market
stocks will be -- hit its lowest level of the year.
Implied Volatility Is TouchingLast Year's Lows...
Last year, this was the point at which everything fell apart. Russia imploded, sending investors in riskier markets, like Brazil, scurrying for safer ones. That turned out to be the exact opposite of what some highly leveraged funds, like
Long Term Capital Management
, thought was going to happen, and the whole world financial system comes damn close to collapsing.
This year, people wonder whether it's going to happen again. Not the whole Russia-Brazil-Long Term Capital Management scenario
. There's a school of thought that says the market sets itself up for these things when valuations and complacency get too high. Stocks have followed the same pattern as last year, and now the bogeyman will come -- even if it's necessary to invent him.
... And This Year's Market
If that sounds like too simple an analysis, it's probably because it is.
"One of the characteristics of the human mind is that we love to find patterns," says Howard Simons, quantitative strategist at
Fimat Futures USA
. "Even if they don't exist."
Simons points out that, besides the surface similarity, there are incredible differences between the fundamentals of today's market and those of last year's. In the selloffs of 1997 and 1998, the worry was deflation, the symptom of a weakened world economy. The worry today is reflation, economies growing quickly enough to cause inflation.
And even if some things do look a lot like last year, so what? asks John Manley, market strategist at
Salomon Smith Barney
. "It's going to be exactly the same until it's different," he says. "Any parallels you draw are by definition at their closest until they diverge."
... Is Beginning to Look Like Last Year's
For Manley, the idea of the necessary catalyst -- that because things look similar to last year, something bad will come around to send the market crashing -- stinks of alarmism. Last year was, by his lights, a 10-year event. "You've seen these levels of complacency before," he says. "You've seen these high valuations before." And in most cases, those have prompted no more than what Manley calls a scare -- one of those 10% corrections that long-term thinkers like him are best ignoring because "you miss the first 5% down, and you miss the first 5% back."
Others point out that, unlike last year, when at least there was trouble in emerging markets to worry about, it's hard to envision what would spark big selling these days. The
may have a predilection to tighten, but surely not in the way that could prompt financial panic. Financial crises scudding in from overseas seem unlikely, too. "What's this year's Russia?" asks Simons. "We already blew up every country in the world there was to blow up."
"Markets don't die just because they wake up one day and die," continues Simons. "Markets get killed. Yes, we have a dry pile of leaves. I just don't see anything out there to set it off."