Investors Prepare, the Caution Lights are Flashing
We get recessions, we have stock market corrections. If you do not understand that’s going to happen you are not ready and you will not do well in the financial markets.
Over the last several weeks in my daily DJIA technical outlook column I have discussed stocks coming in to that time of the year and the break of the market into the downtrend line that began last year.
The rally from the 10 February lows was driven by a tremendous amount of short covering fueled by Bullish optimism. Many are ignoring the caution signals and continue to buy into the optimistic story, as the number of stocks on Bullish buy signals has risen since the 10 February lows.
The Bulls point out the rebound resembles that of Y 2011. But, the reality is the current market set up is more closely aligned with the early stages of a Bear market reversal.
Not many are arguing that the Bulls are in charge currently as the rally from the recent lows is and has been astonishing, even as it enters a Summer’s swoon, the seasonally weak period of the year.
The Big Q: Will the Bullish hopes continue, so far the Bulls have not been able to break above the correction’s trading range
The Big A: The caution lights are flashing.
Many point to the recent correction as a repeat of the 2011 debt ceiling default crisis. But, the real issue in Y 2011 was the economic impact of the Japanese tsunami/earthquake/meltdown trifecta, combined with the absence of liquidity support following the end of QE-2, which led to a sharp drop in economic activity.
While many might suggest that the current environment is similar, there is a major difference.
The Fall-Winter of Y 2011 was fueled by comments, and actions, of accommodative policies by the US Fed as they instituted Operation Twist and a continuation of the Zero interest rate policy (ZIRP).
Plus, the US economy was boosted in Q’s 3 and 4 of Y 2011 as Crude Oil prices fell, Japan manufacturing came back on-line to fill the void of pent-up demand for inventory restocking and the warmest Winter in 65-years which gave a boost to consumers wallets and allowed for higher rates of production.
This friends, is a very much different picture, here is why:
- While the Federal Reserve is still reinvesting proceeds from the bloated $4-T balance sheet, which provides for intermittent pops of liquidity into the financial market, they have begun to tighten monetary policy by ending QE-3 and increasing the overnight lending rate. The changes to the US Fed’s balance sheet is highly correlated to the movements of the S&P 500 index as liquidity is induced and extracted from the financial system.
- Despite hopes of stronger rates of economic growth, it appears that the domestic economy is weakening considerably as the effects of a global deflationary slowdown wash back onto the US economy.
- While services seems to be holding up despite a slowdown in manufacturing, the service sector is being rendered confused by sharp increases in healthcare spending due to sharply rising costs of Barack Obamacare premiums. While the diversion of spending is inflating the services related part of the economy, it is not a representation of a stronger real economy that creates jobs and increased wages. Overall the services sector has been weakened by Obama administrations policies.
- The USD is responding, and is back on the rise, and
- With the revelation of the recent FOMC mins the worries about a June/July rate hike have surfaced sending the Buck spiking above Resistance.
Should the US Fed hikes rates in June higher rates will attract foreign money into US Treasuries in search of a higher yield. The USD will strengthen further impacting commodity and Crude Oil prices, as well as increase the drag on companies with international exposure.
Exports, which make up more than 40% of corporate profits, are sharply impacting results in more than just the energy-related sectors. This is not just a profits recession, it is a Revenue Recession, they are 2 entirely different things.
It is important to remember that US markets are not an Island.
What happens in global financial markets will ultimately impact the US. But, the weakness in the international markets is being dismissed by some investors, but it most likely should not be considering the ECB’s recent Bazooka of QE has failed.
The Summer, seasonally weak period of the year may be a good opportunity to reduce risk as we head into the Dog Days
When we consider the high-valuations of stocks, uncertainty about what actions the US Fed may take, ongoing geopolitical risks, concerns over China, potential for a stronger USD, and more weakness in Crude Oil, there are many catalysts to push stocks lower during this traditionally weak frame.
There is never certainty in the stock market, but this Summer the “deck” looks to be stacked against participants taking on excessive equity based risk.
The Big Q: Is the reward is really worth the risk?
On the surface the recent rally off of the 10 February lows was encouraging, but it has failed to change the underlying momentum (Stochastic) and relative strength indicators (RSI) enough to suggest a return to a more structurally sound Bull market.
The price action confirms the relative weakness, as the recent rally has focused on the largest cap companies, the action is reminiscent of a market topping process (the rounded top pattern) than the beginning of a new leg of the Bull market.
The current market dynamics are not as stable as they were following the correction in Y 2011. This is the case given the US Fed’s threat of a tightening of monetary policy combined with significantly weaker economic underpinnings.
The investors challenge: to navigate this coming weak period of the year Vs a backdrop of flashing caution signals.
The media always Bullish, as it moves to dismiss caution signs as just being Bearish, such unheeded warnings have ended badly for individual investors. For professional investors the media is Noise and it is tuned out.
Remember, cash is an asset, the name of the Wall Street game is to make money and there will always be a trade. It is prudent to heed the caution lights.
Have a terrific Memorial Day weekend.
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