Forget the New Year's celebration and optimism. Shake off the holiday cheer. Ignore the euphoria over the fiscal cliff deal. There is pain coming in 2013 for pretty much everyone, especially investors.
In fact, we could be on the cusp of a powerful new bear market in stocks. The more I review the data and examine the year-ahead research, the more worried I become. Over the past two weeks, I've sketched out why a new recession looms (see "Welcome to the new recession") as well as why it could prove to be a great buying opportunity for the long term (see "A happy new year -- eventually"), in an effort to dull the pain of what's coming.
But first, we've got to trudge through the muck. And the evidence suggests that both Wall Street insiders and Main Street everymen are beginning to position themselves for the pain.
A recent piece by The Associated Press provides the basic outline: Average Americans have lost faith in equities and have consistently been selling into strength over the past few years, something that hasn't happened since records started at the end of World War II. Since early 2007, the AP calculates, $380 billion has been pulled out of the market, equivalent to all the money put in between 2002 and 2007. The new craze has been in bonds, a perceived safe haven that has attracted more than $1 trillion since 2007.
Anthony Mirhaydari
I can't say I blame those investors.
Wall Streeters are pulling out, too. Major banks' short-term Treasury bond holdings have surged since 2011's credit-rating downgrade and the subsequent market meltdown. Over the past few weeks, total holdings have climbed to a record, according to Federal Reserve data.
This is the equivalent of hunkering down in a bomb shelter.
Exodus in action
Stocks are unattractive because the economy is unattractive. Deep, structural problems remain unresolved, discouraging fresh money from coming into stocks.
Middle-class households are still struggling with stagnant wages, higher prices for food and fuel, higher medical costs and, now, rising rents. Young adults are on the same tragic trajectory as Japan's lost generation, as economic turmoil is poised to do lasting damage to their lifetime earnings. These folks are having trouble moving out of Mom's house and paying their student loan debt, let alone investing a meaningful portion of their income in equities.
At the same time, boomers are starting to pull money out of stocks as they approach retirement, shifting to bonds and cash in a big way.
The result has been a drop in NYSE market volume to levels not seen since 1998.
The thinning has been accompanied by other, related trends: the rise of predatory computer trading algorithms, hedge fund insider-trading shenanigans and cross-asset correlations. For most people, the playing field is not level, and portfolio diversification does not offer the safety it once did. Plus, the heavy hitters now actively play against the little guys, using strategies with names like "momentum ignition" and "quote stuffing."
All this has investors throwing their hands up in disgust. Add in the economic head winds starting to develop -- from corporate profit margin pressure (slowing top line growth and an already streamlined cost structure) to fiscal austerity by rich-world governments (even a best-case bipartisan resolution to the looming debt ceiling fight would see taxes go up further and spending fall) to new recessions in Japan and Europe -- and we're in the early stages of an outright exodus.
Stepping back, this decline in NYSE volume reverses an uptrend that began in the late 1940s -- which itself marked the end of the Great Depression malaise.
Put another way, this is no ordinary market. And traditional rules based on the multigenerational performance of the stock market don't apply -- including the belief that retail investor flows are a contrary indicator worth betting against.
Risk abounds
What's worse is that if the market drops out of the sky next year, it's hard to see any near-term positives breaking the fall.
Households remain under intense pressure, with the job market stalled and home prices well off their highs. The government and the Federal Reserve have already made exhaustive efforts to solve the problem, as have their overseas equivalents. We've done stimulus fueled by debt and deficit. We've done currency debasement and ultracheap money. Not much is left, as the new leadership in Tokyo tasked with ending Japan's long debt-depression death spiral is about to realize.
Although I mentioned a few positives last week (strong corporate balance sheets and excess liquidity, mainly) the path out of this is tricky and strewn with dangers.
There is the risk of political unrest (witness Greece's violent protests) and gridlock. There is the risk of an outright global currency war as all the major economies try the currency-devaluation trick in a simultaneous push to boost exports -- a war the Brazilians claim to be winning. There is a risk of credit-rating downgrades on a lack of deficit reduction -- which Moody's warned of last week. And there is the risk of a bloody end to the stalemates in the Middle East, with flare-ups possible on the Israeli-Iran, Israeli-Arab and Sunni-Shia fronts.
And the bond market is looking risky as well. As I explained two weeks ago, people are overpaying for the "safety" offered by corporate bonds, ignoring the risk of default or a rise in interest rates. With rates so low, exposure to these risks -- and the potential losses from them -- is much higher than many realize.
(Bond traders are already familiar with this concept, known as "duration," that results in steeper losses on small increases in interest rates. Lower overall interest rates, all else equal, will increase duration and therefore exposure to losses.)
From a purely technical perspective, warning signs abound that the current bull market is on its last legs.
