Proinsias O’Mahony: What’s happening in the stock market?

US bull market continues to tire US markets continue to hover around all-time highs, but a large number of stocks are already in individual bear markets.

One in five S&P 500 stocks has declined by at least 20 per cent.

The deterioration is stark – a year ago, just 4 per cent of large-cap stocks had suffered declines of that magnitude.

Early last week, just 57 per cent of stocks were trading above their 200-day average, the lowest figure since last October’s correction.

Only one third of stocks were trading above their 50-day average.

Such behaviour is often seen at market tops or intermediate-term highs, with indices being pulled higher by a declining number of large-cap stocks.

Research by award-winning technical analyst Paul Desmond indicates that at past market peaks, around one fifth of stocks had already already suffered 20 per cent declines.

Now, one should never make too much of one indicator. Additionally, market breadth has not collapsed; other breadth measures are less alarming.

Still, the six-year bull market has looked tired throughout 2015, barely eking out gains even as international indices surged higher.

Unless breadth figures improve, traders are likely to view new price highs with suspicion. Bulls in short supply While bulls may be concerned by waning market breadth, they can console themselves that investor sentiment is nothing like that seen at past peaks.

Just 20 per cent of investors feel bullish, according to the latest American Association of Individual Investors (AAII) poll.

That’s the lowest figure in more than two years, barely half the historical average, and just a whisker above the 19 per cent reading registered in early 2009, at the very height of the global financial panic.

There are more bears than at any time since October’s correction, while the spread between bulls and bears is the most negative in almost two years.

The dumb money is not always wrong; ordinary investors were very pessimistic in July 2008, for example, not long before market mayhem ensued.

However, research confirms low levels of bullishness are associated with above-average returns over the following six- and 12-month periods, with stocks gaining on 85 per cent of occasions.

Contrarians like to say the time for selling is when the crowds are yelling. That’s not the case at present.

Betting on a bubble There is a 60 to 70 per cent chance stocks will end up in bubble territory, Credit Suisse cautioned last week.

It reasons that “bull markets in most assets end in bubbles”, and that various forces – for example, rates being kept “abnormally low” for too long as well as retail investors eventually piling into stocks – could trigger market excess.

However, while Credit Suisse’s bubble warning hit the headlines, the full note was more sanguine.

It listed eight preconditions for an equity bubble – talk of new investing paradigms, a belief earnings are irrelevant, over-investment, bullish sentiment, and so on.

Credit Suisse found no evidence of excess in six of the eight cases, and a “modest” increase in two cases (merger and acquisitions activity as well as expectations regarding corporate profitability).

In other words, while stocks may well eventually end bubble over, there is precious little excess at the moment.

Why cheer stock splits? Investors cheered Netflix's confirmation last Wednesday that it is to split its stock – shares hit all-time highs following the news.

Splits are purely cosmetic. You wouldn’t be delighted if you split a €100 bill into two €50 notes, so why applaud stock splits?

However, there’s a lot of evidence that stock splits are a bullish signal.

One famous study found that between 1975 and 1990, firms splitting their stock outperformed by 7.9 per cent over the next year and by 12.2 per cent over the following three years.

Another research paper found similar results during the 1990s.

More recently, a 2012 study found companies that split their stock delivered better earnings over the following two years.

Splits are typically done by high-flying companies like Netflix, which has risen from $53 in late 2012 to over $690 last week.

Do such companies continue to deliver the goods? Are splits are a statement of confidence from management?

Does the lower stock price attract more investors?

Who knows, but the evidence indicates the excitement around splits is less irrational than it seems. Judging 'Flash crash' traders The UK courts continue to reject Navinder Sarao's appeal for looser bail conditions. In jail for eight weeks now, the trader accused by US authorities of triggering the infamous 2010 "flash crash" faces a maximum 380-year sentence if convicted.

But consider the case of another trader, Igor Oystacher. Last November, he received a $150,000 fine and a one-month ban for trading activities similar to Sarao's. He's just been fined again – $125,000 – and asked to "desist from future violations".

Sarao must be looking on in bewildered envy