Arbeter: Risk Rising for Stocks

S&P's technical strategist cites "frothy" equity market conditions and says crude oil could hit $100 before seeing a major correction

We think the battle lines are drawn and it is not the housing market vs. the global growth story, but the bullish seasonals vs. the overly extended sentiment readings (too many bulls).

So far, the first battle is being won by the global growth story. We, however, are not as confident that the favorable seasonals can trump the extremely high levels of bullish sentiment.

We were hoping that sentiment would not get too bullish, and in our view, give the market more time to advance through what typically is the best three months of the calendar for stocks. However, things are just getting too frothy, in our view.

In addition, we see the rotation into materials, energy, industrials, foreign stocks as getting very crowded, so it is very possible that we could see some type of value rotation back to the areas that are still laying on their backs, like financials. The weak U.S. dollar trade seems to be on everyone's lips so we are worried that some air has to be let out of these stocks.

Put/call ratios have dropped to levels that have preceded intermediate-term corrections in the past. The ISEE sentiment index (calls/puts) recently hit the highest level since August 2006. Investor's Intelligence newsletter poll had 62% bulls and only 19.6% bears a couple weeks ago, about the most lopsided this survey ever gets. The combination of Consensus and MarketVane polls hit 144% two weeks ago, close to the highest percent of bulls seen. Trading on the Nasdaq has been very heavy vs. the NYSE, a sign that speculation is rising.

Emerging markets have gone asymptotic as speculation grows overseas. Chinese markets have almost gone straight up since the lows in August, and sit quite a distance from any meaningful support levels. We think risk is most pronounced with these highflying stock markets.

Crude oil prices have hit new highs, and are currently trading over $94 per barrel. We think there is a good chance that crude oil could run up to the $100 zone, but then we believe there will be a major correction in prices.

While we think the U.S. stock market could trudge higher into the end of the year, we see increased risk, and are raising the yellow flag.

We would use market strength to take profits as we believe most of the gains from the current intermediate-term uptrend are behind us. We would be very careful with high momentum stocks that have worked so well over the past couple of months.

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