Clearly the market is in bullish mode, and as readers of WSR know, we have been bullish since the infamous Nouriel Roubini Bottom last March. But we remain cautious, with an eye towards the exit signs, as the bull climbs the “wall of worry” amids declining volumes. The low hanging fruit has been picked off, and stocks are not that “cheap” anymore.
The market has been rising on upside surprises, and “less worse” news. The question is: When will this stream dry up?
The United States government, including the Federal Reserve, has done so much to avert a collapse over the last 18 months that it’s truly no surprise the markets are recovering since March. Indeed, during the second quarter the first wave of government spending boosted GDP – even though growth contracted 1%.
What’s interesting to note about this global market recovery – skyrocketing since July – is how the market is responding to the flow of events. In many respects the markets are drunk with joy again just like pre-2007; emerging markets, junk bonds and other risky assets are soaring almost nonstop since March.
Even credit markets, which have seen short-term lending rates collapse – have barely corrected. I’m not sure a bout of profit-taking at this juncture isn’t a bad thing. Yet the higher we go the greater the scope for disappointment if employment, earnings, banks, consumption, housing – anything falls apart. This remains the worst contraction in output since WW II and the most spectacular deflation in credit and housing since the 1930s. Suddenly, everything is fixed and we’re off to the races…
Leading up to March, stocks were declining almost every day as it seemed we were heading into Great Depression II. The news was extremely bearish in early March and that proved to be a good time to buy or add to stocks. But now it seems that we might be at a turning point when good news is failing to support the market. This might be a good time to sell or “get out of Dodge.” It’s like the whole world is overbought. I truly can’t find very much to buy. But I can find a lot to short.
The greatest short speculations can be purchased through reverse index funds. Even if this is the Mother of bear market rallies there’s bound to be a period of profit-taking. “Bubbles” include Chinese and most emerging market stocks, emerging market debt, junk bonds, industrial metals, 30-year Treasury bonds and possibly the euro.
But short-sellers beware; July capped the best five-month rally for U.S. equities since 1938. That’s a dubious statistic. Yet the markets surged more than 400% from their lows in the summer of 1932 until late 1936. This rally might go much higher before it hits a cliff – just like it did in 1937.
I remain in the bearish camp – a dwindling lot since June. Yes, the stock market is now officially in bull market mode since Dow Theory turned bullish on July 23 when both the Transports and the Dow hit new highs for the year. Still, I don’t depend on just Dow Theory to make an investment decision. Neither should you.