There probably is a similar parade of bulls somewhere. (Photo by Mario Tama/Getty Images)
There probably is a similar parade of bulls somewhere. (Photo by Mario Tama/Getty Images)

The Standard & Poor's 500 Index hit an all-time high yesterday, closing at 1,897.45. The Dow Jones Industrial Average also hit a record, ending at 16,715.44. This should be tempered by noting that the Dow is up less than 1 percent so far this year, while the S&P 500 has gained about 2.7 percent. One big down day can erase all gains for the year.

The small-cap Russell 2000 Index has been playing the spoiler, failing to reach new highs. Perhaps this is less surprising, after last years’ blistering 38 percent gain for the Russell, and 43 percent run-up for its growth index. No one expects new records anytime soon from the Nasdaq Composite Index. It is up about fourfold from its 2002 low, but still is almost 20 percent below its peak more than 14 years ago.

Each new set of highs seems to be greeted with derision and skepticism. The evidence shows that new highs are bullish, but that seems not to matter very much to the skeptics. The U.S. economy is the cleanest shirt in the dirty hamper. Year-over-year increases in corporate revenues and better-than-expected earnings should also give investors a reasonable basis for anticipating equity gains.

This morning, I want to take a quick look at what is bullish and bearish for stock markets.

Bearish

Small cap weakness: From my perspective, the Russell 2000 weakness is the most bearish indicator going today. As we explained in ``How Market Tops Get Made,'' the small caps are the first sector to get hit when bull markets start to morph into bear markets. The weakness in the small cap index is worth watching closely as a precursor to a bear market.

Given the scalding pace of last year’s gains, it is possible that the index merely got ahead of itself, and is now going through an overdue correction. It is, in my opinion, too soon to make that call. Time will tell which of these opposite perspectives will win out, hence why it warrants close watching.

Valuations: They continue to creep up. Depending upon the measure you want to use, stocks can be defined as cheap (the rule of 20, which adds the inflation rate to a stock index's price-earnings ratio) or fairly priced (forecast P/E), somewhat overpriced (12-month trailing P/E) or wildly overpriced (Shiller's cyclically adjusted P/E).

Note that each of these valuations come with caveats and asterisks, with earnings only one important factor that drives valuation.

Economy: The U.S. economy had no growth in the first quarter, but investors seem to be giving gross domestic product the benefit of the doubt, courtesy of a horrific winter of record freezing temperatures and snow that blanketed the nation. Retail sales in April were soft, housing seems to be faltering and auto sales are unimpressive.

There are increasing signs of improvement as we play catch up with deferred purchases and hiring. The stability and gradual improvements in the U.S economy, weak though it is, look good relative to the rest of the world.

Economics, technicals and valuations are the negatives. What are the positives?

Bullish

Tech-stock correction: Expensive darling tech stocks have been severely punished for their high flying ways. As the chart we showed Monday demonstrated, these stocks have gotten slaughtered. Twitter Inc. is down 56 percent from its record high, Groupon Inc. is off 50 percent, LuluLemon Athletica Inc. is down 45 percent while Yelp Inc. has declined 43 percent. The full list of bloodshed is impressive.

I take this as a sign that rationality is returning to that part of the market, as traders suddenly discover that paying any price for hot names is no longer such a bright idea.

Revenue and earnings growth: Despite the forecast of the skeptics, corporate revenues and profits continue to rise. With only a few stragglers left in the S&P 500 to report first-quarter results, the numbers have been a pleasant surprise. The Wall Street Journal reported that “Earnings per share are now expected to be up 2.2 percent from year-ago levels, according to FactSet, versus expectations in March for a 1.2 percent decline.” FactSet also notes revenue has increased 2.8 percent from last year.

Sentiment: There is a deep reservoir of skepticism of the markets. The rate of initial public offerings has been modest compared with other IPO bubbles, with even profitable companies only seeing modest gains. Mergers and acquisitions have been dominated by headline-grabbing megadeals, but the pace is also below earlier levels. Currently, M&A activity is more focused in the eurozone. Despite these elements, the contest to call the next top continues unabated.

The key takeaway is that markets are Rorschach inkblot tests. There is enough positive and negative information that one can read pretty much whatever one wants into the data. The challenge is to do so in a way that doesn't give in to your confirmation biases and market positions.


To contact the author of this article: Barry Ritholtz at britholtz3@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.