Investors are very scared even with stocks near record highs

The Dow and S&P 500 are both up about 15% in 2021 and are each about a percent away from their all-time highs. But as Friday’s market sell-off showed, investors remain extremely nervous about the market.

The CNN Business Fear & Greed Index, which looks at seven different measures of market sentiment, is showing signs of Extreme Fear. Four of the seven indicators are in bearish territory.

Demand for safe haven bonds is picking up. That’s pushed the benchmark 10-year Treasury yield all the way down to 1.3%, compared to a level above 1.75% as recently as March.

Investors are also buying more put options, contracts that give them the right to sell stocks and other assets at a specific price.

The number of companies with stocks hitting new 52-week lows versus highs is increasing, and trading volume for stocks that are falling is also outpacing volume for stocks that are climbing. But the solid gains for the FAANGs of Big Tech have helped lift the broader market in spite of this.

A little bit of fear is healthy

There are several legitimate reasons for investors to be worried.

Even though the economy and corporate earnings have rebounded sharply from their pandemic era lows of last spring and early summer, worries persist about the Delta variant and the fact that many Americans remain unvaccinated.

There are also conflicting signs about the recovery. The US government reported a sharp rebound in retail sales for June on Friday but that was complicated by another report showing a sizable drop in consumer confidence.

The persistent rise in the prices of many consumer goods is raising inflation alarm bells as well.

The New York Stock Exchange stands in lower Manhattan on May 11, 2021 in New York City.

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Still, some market experts believe that the skepticism is healthy.

There’s a saying on Wall Street that stocks climb a wall of worry, meaning that it’s a good sign if the market is going up even though there are legitimate concerns. The absence of such worry can often lead to excessive speculation and market bubbles.

“It’s not abnormal after you have a jolt in the economy and market to have lingering fear. It takes a long time for investors to become comfortable with advances in stocks coming off the bottom,” said Kelly Bogdanova, vice president of the portfolio advisory group with RBC Wealth Management.

“I’d rather see some fear than people being complacent. Investors being nervous doesn’t trouble me,” she added.

Bumpier ride for stocks but path of least resistance is up

That being said, investors may have to brace themselves for more volatility in the coming months.

The so-called easy money in stocks may have already been made during this year’s stock surge. Bogdanova said that “the market is now entering a transition period” and instead of “explosive growth, it will be a two steps forward and one step back” type of environment.

Inflation concerns and skittishness about how the Federal Reserve will react to headlines about higher prices are likely to stick around too. But the recent slide in bond yields might actually be an encouraging sign for investors.

If the bond market was really that afraid of inflation, yields would be rising instead of falling. Inflation typically leads to much higher interest rates, not the other way around.

NEW YORK, NEW YORK - MARCH 17: A man walks in front JP Morgan office on March 17, 2021 in New York. JPMorgan Chase & Co is planning to have its interns working from offices in London and New York City, around June when the program begins but cautioned that the idea will depend on government guidance. (Photo by John Smith/VIEWpress via Getty Images)

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So it would appear that bond investors agree with Fed chair Jerome Powell, who has repeatedly described the current bout of inflation as “transitory.”

“The bond market is giving the message that inflation concerns are not permanent,” said Steve Wyett, chief investment strategist with BOK Financial.

There’s also the fact that corporate earnings are expected to keep climbing. That bodes well for stocks.

According to FactSet, analysts expect corporate profits to rise 24% from a year ago in the third quarter and increase nearly 19% in the fourth quarter. Growth is expected to dip somewhat next year, but analysts are still forecasting a healthy 11% increase in earnings for 2022.

What’s more, profits are climbing even as many companies are raising wages to entice people back into the work force.

“There is room for companies to pay more for labor and not hurt their margins,” Wyett said. “We should see continued earnings growth. The stage is set to go from a stimulus led recovery to one with private sector expansion.”