A colleague recently issued me a challenge. In short, my long-time friend teased that I needed to remove my rose-colored Revo's, if only for a moment or two, and try to look at the stock market environment from a member of the bear camp's perspective. Although I am indeed a card-carrying member of the glass-is-at-least-half-full club when it comes to the outlook for the U.S. economy and, in turn, the stock market, I am also a professional risk manager. And since removing emotional bias is part of the game, I welcomed the challenge.
What my colleague did not know is that I am nervous about the current state of the market and that I regularly spend some time on the dark side, looking at what could go wrong. As such, said challenge, wasn't really much of a challenge at all. It turns out that within 10 minutes, I had compiled a list of nearly 20 reasons that investors may want to take their foot off the gas a bit at this stage.
The plan then is to spend some time in the coming days plowing through this relatively lengthy laundry list of stock market worries. So, without further ado, let's get started. Finally, please note that the "worries" to be presented are in no particular order.
The Fed's Exit Plan
One of the oldest cliché's on Wall Street is "Don't Fight the Fed," to which, I have added "... Especially when they are on a mission."
The current market cycle is an absolutely perfect example of this trading rule. In short, the Fed has been on a mission to make double-darned sure that the U.S. economy does not enter a Japan-style deflationary environment. Therefore, the FOMC has come up with all kinds of new and creative ways to provide liquidity to the system.
And what has happened to all that money, they've been printing, you ask? It would appear that an awful lot of it has wound up in the stock market. The bottom line is that rising stock prices make people feel better. And when people feel better, they spend more time at the malls. In turn, the economy improves, etc., etc., so what's not to like, right?
The problem is that the actions taken from 2007 through 2013 by Mr. Bernanke and now Ms. Yellen in 2014 have been unprecendented. Therefore, no one really knows what will happen when they try to return interest rates to more "normal" levels (remember, current rates are at generational lows). However, we DO know that (a) the Fed WILL be starting to exit its easy money policy in the next year and (b) that a rising interest rate environment has not generally been kind to the stock market.
Inflation: Public Enemy #1 of Stock Market Bulls
To be sure, it has been a while since investors have had to worry about inflation. However, history shows that one of the biggest killers of bull markets is rising inflation.
Back in the day, the Fed focused primarily on keeping inflation in check. But of course, these days Ms. Yellen and company are actually trying to produce some inflation in the economy.
The problem is that once inflation takes hold it can prove very difficult to stop. Thus, one of the biggest worries is that the Fed's uber-easy monetary policy will once again prove to be the cause of the next stock market problem - namely, inflation.
Remember that the Fed's "target" for inflation is 2.0% per year. Last October, the annual CPI rate stood at 1% so there was no need to worry. However, in May the year-over-year CPI came in at 2.0%. In June it was 2.1%. The "Core Inflation" (excluding food and energy) rate was 1.9% and the "CPI Services" (less energy services) was reported at 2.7%. Note that all of these numbers are above the Fed's target.
Yes, I understand that Ms. Yellen is focused on Core PCE. However, it is important to recognize that the real inflation worry lies in wage inflation, which at this stage, remains under control. Everybody knows that consumer incomes have not been rising to any great degree, that plenty of folks are still out of work, and that there continues to be "slack" in the labor force.
Thus, the key is to watch the data for wage inflation. Should this begin to pick up, the stock market could have a problem on its hands.
This Bull Is Long In The Tooth
Some folks argue that the current bull market began on March 9, 2009 while others contend that 2011's rapid dance to the downside (which was tied to Greece and the U.S. debt downgrade) was technically a mini-bear and thus, the current bull started in November 2011. However, the key is that the average bull market lasts a little over two years. Therefore, regardless of where one begins counting, this bull is getting old.
Perhaps more important is the fact that it has now been more than 800 days since the stock market saw a correction of 10% or more. The problem is this. Over the last 50 years, the longer the time that the market spent going up between 10% corrections, the bigger the eventual decline has been.
For example, since 1965, the declines that began after the stock market had advanced without a 10% pullback for more than 500 days were: -14%, -19%, -34%, -22% and -19%. So... investors may want to implement a sell-first-and-ask-questions-later approach if the bears can finally get something going to the downside.
And since the recent declines have all been shallow, we will definitely sit up and take notice should a pullback exceed the -5% mark. In essence, this would be a sign that the bears might be in control.
Tomorrow, we will make some more check marks on our list of reasons to be cautious and look at the issues of liquidity, the nearest neighbor to the current advance, speculation and...
Turning To This Morning
Better than expected Industrial Production numbers out of China led to big gains in Asia overnight. However, across the pond, concerns about how Russia will react to new sanctions, the ongoing fighting in Ukraine, and the situation in Gaza/Israel are keeping a lid on stock prices. Here at home, traders are waiting on more data after the open, which is currently projected to be modestly lower.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
- Japan: +0.46%
- Hong Kong: +0.88%
- Shanghai: +2.42%
- London: -0.01%
- Germany: -0.25%
- France: +0.13%
- Italy: -0.31%
- Spain: +0.38%
Crude Oil Futures: -$0.62 to $101.47
Gold: +$2.00 at $1305.30
Dollar: higher against the yen, lower vs. euro and pound.
10-Year Bond Yield: Currently trading at 2.481%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -1.64
- Dow Jones Industrial Average: -10
- NASDAQ Composite: -1.11
Thought For The Day:
A great fortune depends on luck, a small one on diligence. -Chinese Proverbs
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