Stocks Start Showing Some Cracks

NEW YORK ( TheStreet) -- Judging by the calendar, the bears are supposed to be sleeping for a while yet. But looking at the market of late, it's just as likely they're sharpening their claws.

Sure, the Dow Jones Industrial Average kept its winning streak intact, rising for an eighth straight week. But the action was actually pretty choppy -- two up days and two down -- with the individual names like General Electric ( GE) and International Business Machines ( IBM) posting outsized gains that masked broader weakness.

Or as Jim Cramer put it shortly after Friday's closing bell over on Real Money: "We just had one of THE most brutally positive weeks I can recall in years."

Among the major U.S. equity indices, the Dow was the only man left standing. The S&P 500 fell 0.7%, and saw its seven-week winning streak come to an end. The Nasdaq Composite took a drubbing, losing 2.4%. Sentiment about the tech sector took a big hit when high-flier F5 Networks ( FFIV) disappointed and investors began to sell off shares of not only its competitors but those of companies who'd enjoyed similar stratospheric gains that put them in the same "priced for perfection" territory.

But the biggest evidence of confidence being shook in the broad market was the decline in the Russell 2000, which fell 4.3%, wiping out roughly half of its gains since the start of this inexorable march higher by equities in early December.

And while the Dow was able to climb 85 points in the holiday-shortened week, this eight-week streak may be cause for concern in and of itself. After all, most market observers would agree a pullback's got to come at some point, if only to placate the technical crowd. A tree can't grow to the sky and all that.

The last time the Dow put together a similar run was an eight-week ramp-up that wrapped up on the week ended April 23, 2010. The following Monday, April 26, the blue-chip index peaked above 11,300 on an intraday basis, rising more than 100 points, but closed roughly flat. The day after that, concerns about Greece's debt situtation and the threat of contagion elsewhere in Europe took hold and last summer's rollercoaster ride (mostly scary dips) had begun. The Dow didn't climb back above that 11,300 level for more than six months.

Okay, so the Dow may look overheated. But the problem here, as it is in any bull market, is timing the top. That's the real insidious challenge. If earnings are good and the Federal Reserve is locked into "QE2" through the end of the second quarter, what's there to worry about?

A few things actually, as the bearish datapoints are starting to pile up a bit. Independent research firm TrimTabs, which focuses on stock market liquidity, pointed out a few in its Jan. 19 Weekly Flow report entitled "Equities Look a Little Toppy."

One is a plunge in short interest on the New York Stock Exchange in the second half of December, the most recent data available. The NYSE said short interest fell 5.5%, a decline of roughly 730 million shares, to 3.3% of total shares outstanding, a level that TrimTabs said is the lowest level since the Dow's peak above 14,000 in October 2007. So a whole lot of folks threw in the towel on betting against stocks as 2010 wound down.

Another is the level of margin debt taken on ahead of the rally, proof that "speculative juices are flowing freely on Wall Street" as TrimTabs so colorfully puts it. NYSE margin debt rose 1.6% to $274 billion in November, the highest level since September 2008, when the financial crisis hit full bore with the implosion of Lehman Bros.

That peak was the culmination of a four-month 16.3% buildup that occurred during a period when the S&P 500 appreciated 7.1%, which TrimTabs said "suggests investors are taking active risks" with hedge funds believed to be "leading the margin debt charge," according to its survey. That would seem to indicate the so-called "smart money" has done quite well with borrowed money in the past two months, leaving retail investors in danger of being left holding the bag when they cash out.

Then there's the latest BofA Merrill Lynch Fund Manager survey to consider. Turns out a net 55% of asset allocators now identify themselves as overweight on global equities, according to the January survey released this week. That's the highest level since July 2007 and a tremendous leap from just 40% in December.

U.S. equities, unsurprisingly, are getting plenty of love with 27% of the fund managers saying they're overweight in this area, the biggest percentage since November 2008 and up markedly from just 16% in December.

"Investors believe monetary easing is working; in the absence of either tighter policy or weaker data, equity enthusiasm looks contagious," said Michael Harnett, the chief global equity strategist for BofA Merrill Lynch in the press release accompanying the numbers, underlining the fever pitch the rally seems to have reached.

This week's action in the VIX was also telling. The index is a measure of implied volatility drawn from the action in options of the companies in the S&P 500. Also known as Wall Street's fear gauge, the VIX is a good old fashioned contrary indicator. The lower the number, the less risky the market perception of equities is, so if it's too low, there's a good chance investors are too bullish. After closing last Friday at 15.46, its lowest weekly finish since early July 2007, the VIX rose in all four sessions this week, increasing to 18.47. Some of the more sophisticated investors are getting more nervous it seems.

A deluge of quarterly reports is poised to overwhelm the market next week as 127 S&P 500 companies are slated to disclose their numbers. Twelve Dow components will open up their books, including AT&T ( T), Caterpillar ( CAT) and Procter & Gamble ( PG). Some top momentum names will also be issuing their reports, including Netflix ( NFLX), which has to have more than a few holders sitting on heavy gains thinking about cashing out just in case. Look at the action in the stock this past week, that ( AMZN), deal for the rest of Lovefilm wasn't that scary. (A high-flier in its own right, reports next week as well.)

So there will be plenty of headlines to trade off and a myriad of mixed messages to sift through in terms of what one company's good or bad performance/outlook means for its competitors or the economy at large.

Financials have been center stage in the early going and the results have been gloriously inconclusive. JPMorgan Chase ( JPM) did well, the other big names (although Citigroup ( C) was still fine with giving CEO Vikram Pandit a salary boost to $1.75 million from $1) not so much.

Of the 81 S&P 500 components that have reported so far, according to the latest Thomson Reuters data, 26 have been financials and while majority have outperformed, their surprise factor has been just 2.2%. Not exactly blowing estimates away. At this rate, it's hard to see them showing any leadership for the broad market once the dust clears from reporting season and the door really and truly swings shut on 2010.

It could be that the statement accompanying Federal Reserve's rate decision on Wednesday makes some noise after all. Membership on the Federal Open Market Committee changes at the start of each year, and the new voices could spook the markets with even the slightest hint that a tightening agenda is starting to materialize in the mist.

-- Written by Michael Baron in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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