When "Who's your broker?" becomes a more common cocktail party conversation opener than, "Can you believe Murdoch wants to buy Dow Jones ( DJ)?" then it's time to worry about sentiment getting too bubbly. Only when investors stop marveling at other people's deals and start turning to their own stock picks will it be clear they have stopped "doubting this rally" and have gone all-in, says Tobias Levkovich, chief equity strategist at Citigroup. For now, "reluctance will breed gains," he says. Even as the S&P 500 bounced against its record closing high Monday, many investors remain wary of the stock market's rally. Their skepticism suggests there's probably still room to go. The S&P 500 spent much of the afternoon north of its record closing high of 1527.46 hit on March 24, 2000. But the broad market index closed off its intraday best, ending up 0.2% to close at 1525.10. The Nasdaq Composite closed up 0.8% at 2578.79 Monday thanks to strength in big-cap tech names like Amazon.com ( AMZN) and Apple ( AAPL). Meanwhile, the Dow Jones Industrial Average finished down 0.1% to close at 13,542.88, pressured by more than 1% declines in Alcoa ( AA), AT&T ( T), and Coca Cola ( KO). The reluctance and disbelief comes from retail investors who continue to park their earnings in overseas investments rather than U.S. stocks. Institutional investors, meanwhile, lack conviction and are being sucked into the market after being frustrated and tired of waiting for a pullback.
"This is a comatose market," says Randy Diamond, trader at Miller Tabak. "It is like zombies coming in buying, just following the herd because they have to put money to work," he says, adding that "the shorts have lost their conviction." Some observers say a new record close in the S&P 500 would precipitate a much-desired pullback. But attempting to call this moment a market top is probably as futile as saying weak retail sales, a 1.3% print on first-quarter GDP or record-high gasoline prices would send buyers packing. "People calling a market top are getting demolished," says Diamond. "If you doubt, you get run over." Indeed the constant stream of buyouts make it difficult to doubt that the market will go up, even if it may be reasonable to doubt the buyouts. Levkovich says that Bain Capital managing director Mark Nunnelly, who presented at a Citigroup investor conference in Armonk, N.Y., last week, said his firm has walked away from some transactions as prices and leverage get too aggressive. Levkovich reports that the managing director talked about how there are fewer broken companies that can be fixed out there, that there are fewer good-quality companies to buy and that private-equity returns may soften as a result. Private-equity firms are interested in doing more deals in developing regions like Asia, where "opportunities may not be as well-trudged through as local ones," says Levkovich.
Certainly, the flip side is true. China's nascent state investment fund agreed over the weekend to buy a $3 billion stake in private equity firm Blackstone's initial public offering, expected later this year. On Monday, Texas Pacific Group and Goldman Sachs' private-equity unit announced plans to buy wireless company Alltel ( AT) for $27.5 billion. Alltel gained 6.7% on the day. Women's health company Hologic ( HOLX) agreed to by Cytyc ( CYTC) for $6.2 billion, sending its shares up 22.7%. Hologic fell 6.3% on the news. Also, General Electric ( GE) agreed to sell its plastics unit for $11.6 billion to Saudi Basic Industries and use the proceeds to buy back shares. GE gained just 0.4% on the news. The worry isn't about private equity buying out utilities, but more about when private-equity firms start taking out cyclical businesses like Chrysler with lots of leverage, says Jeffrey Saut, chief equity strategist at Raymond James. "It's as if they think there will never be another down cycle." But more than buyout fever, investors should watch for the buying stampede as the moment to call a market top, Saut says. "You look for some kind of blue heat upside hour where short-sellers feel like they'll be sick, then there is a peak and a fade-out into the close of trading that day."
Merrill Lynch's emerging-markets strategist Michael Hartnett wrote a list Monday of "what the shorts are waiting for." He notes some emerging-market-specific red flags, but some on his list are cross-market indicators. He includes the CBOE Market Volatility index dropping to 12 to 13 to indicate "glaring equity market complacency." The VIX fell below 13 on Friday but bounced up 4.2% Monday to 13.30. Hartnett also includes China on his list. The shorts, he writes, are waiting for "everyone to stop worrying about China's bubble, i.e. you buy 'skepticism,' you sell 'certainty.' " It's fitting that his list ends with a reminder about China. It is also popular cocktail party conversation, and U.S. Treasury Secretary Henry Paulson begins his three-day strategic development talks with Chinese officials Tuesday. No one expects much to come of out of the confab but empty headlines.