Unwilling to yet call a bear market, I have nevertheless become increasingly negative on this bull market. But despite a rough January, the stock market, as measured by the S&P 500, remains above its 125-day moving average—a level it has held for over a year. As such it would still be premature to call the current bull market over. But it’s not too early to examine why a meaningful move down with a breach of important technical levels, such as the 125-day, will be a reason to adopt a defensive posture, rather than “buy the dip” as so many are already advocating. In the spirit of my first “A Scary Looking Market” post I’ve included some new charts that argue against many of the currently popular bullish arguments. There is good reason to believe that optimism for the ability of the Federal Reserve through monetary policy to engineer strong economic growth is misplaced. Also unlikely to be realized is the hope that stock price multiples will grow further in a Great Rotation of investors moving from cash and bonds into stocks.
As the stock market makes new highs, there are many reasons to worry that the fall could be particularly hard when it comes. I’m no permabear and have not been constantly arguing a bear market is around the corner. Even if I haven’t been the biggest cheerleader of stocks I have been an advocate. For example in August of 2011 I wrote about how, despite negatives, stocks were the best investment options available to most and in my February post this year I argued that despite rising risks investors should continue to hold stocks and a decline was unlikely to transpire until 2014. At the same time, starting in May of this year, as the stock market kept making new highs, I began to argue that risks in 2013 were rising and investors should use the strength to raise cash levels and sell some stocks, particularly money involving a low risk threshold and time horizon. As I look at where the stock market stands at the end of the year, I continue to believe the risks of a bear market being sooner rather than later have only grown.
Investors are pouring money into the stock market. As the market makes new highs, they’re on track to allocate the most money into stocks since 2000, right before that market rolled into a bear market. The so-called dumb money is often late to the party, as most investors buy at highs and sell at lows. Dumb money rushing into stocks is just one more bearish sign in this almost five-year old stock market. But as many short sellers have found, as this market keeps making new highs, famous economist John Maynard Keynes was right when he proclaimed the market can stay irrational longer than you can stay solvent. Bears actively betting against this market are getting killed. No matter how negative the fundamentals, betting against a trend is a good way to go broke. So, now might be a good time to consider what signs will indicate the current bullish trend has reversed, and the time has arrived to head for the exits.
This bull market increasingly looks scary. Setting new record highs and extending deep into 2013 only makes it look more worrisome. It was only a little more than a year ago I recommended investors keep stocks as the largest portion of any long-term investment portfolio. But that advice came with the caveat that market risk would rise in 2013, and indeed I have become increasingly nervous about stocks this year. Although I have yet to declare a market top, and will not call a bear market until important technical levels are broken, I have not hesitated urging taking profits and raising cash levels by selling stocks as this market has set new record highs this year. Pictures can often convey more than words, and in this post I am going to highlight a few notable and scary charts related to the current stock market.
To believe that the stock market will rise significantly from its recent August highs, when the S&P 500 reached over 1,700 points or not revisit near its lows, is to bet that it is different this time. The famous declaration of legendary investor, Sir John Templeton, that, “The four most dangerous words in investing are, it’s different this time” has over the past few months become particularly pertinent. The secular bear market that began in 2000 (when investors believed it was different that time and the Internet had fundamentally changed the nature of the stock market removing the risk of a major bear market) would need to have ended in the 2009 bottom for the stock market to now rise significantly higher or not fall to around previous lows. But there is little reason to believe this time is different, that stocks entered a new secular bull market in 2009, well below the typical duration of a secular bear market and that the odds now favor a heavy allocation to stocks.
With the news that China’s central bank is lowering interest rates, the bull market that began in 2009 is likely entering its final stage, which should carry it into at least the next year. Fears that the current global economic recovery is faltering led not just China’s central bank to cut rates, but the European Union to lower rates from 1 to 0.75 percent and the United Kingdom to increase its stimulus efforts. With a weak June jobs report, expectations of further monetary intervention by the United States also grew. But outside of China, monetary intervention is to a large degree pushing on a string. And even if China can give the world a temporary boost, the expansion of its economy will only provide a reprieve from the onset of the next downturn.
Prospects are excellent for a positive year in the stock market in 2011. Odds are good also for that strength to carry over into 2012, although it’s a bit early to prognosticate on next year. This bull market is still relatively young and should have further to run. Although I am no fan of the accommodative monetary policy of the Federal Reserve believing it led to the housing bubble and is fueling rises in commodity prices today, I am also quick to admit that in the near term it is a positive for the stock market. “Don’t Fight the Fed” is a popular saying among investors for good reason. The economy is growing, stock prices are rising and these trends will likely continue for a time.