Is the Stock Market Rolling Over?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Volatility is a sign of a top. The triple digit up and down moves on the Dow in the last few days should make bullish investors reconsider their view on the market. The 15-month rally has been overdone for quite a long time now and even a small event could do some serious damage to prices.

Investors need to realize that the stock rally has been created on a wave of liquidity even though the mainstream media has continually cited an improving economy and good corporate earnings as the basis for stocks ongoing rise. Careful examination of U.S. economic statistics indicates anything but an improving economy. They instead show an economy dependent on government spending, stimulus and easy money. As for good earnings, if you believe them, ask yourself what earnings looked like in Q3 1929, Q3 1987 and Q1 2000. They were great, but that didn't prevent the market from crashing shortly thereafter.

As for small problems, they have a way of getting bigger. The oil spill in Louisiana is not just a major environmental disaster, but could cause significant damage to the U.S. economy as well. The entire global financial system could take a hit because of problems with the PIIGS in Europe. The euro (FXE) fell to just above the 130 level this morning and that is an important support level. We will have to see if it holds. The EU has handled the situation ineptly from the beginning and has chosen denial instead of action, and proven failed approaches over innovative thinking. China, the epicenter of global growth, also restricted bank credit yesterday for the third time this year.

There is also no question that the technical picture on the U.S. stock market is deteriorating rapidly. However, this has happened before during the last year and the market managed to miraculously recover. Each time, more liquidity came to its rescue. At some point though there is no longer enough extra liquidity  to juice the market. While the U.S. Fed has made it clear that it will be keeping interest rates close to zero for a while longer, it is slowly closing down special support programs created during the Credit Crisis. The U.S. is no longer in control of the world economy, nor markets however. Investors need to pay more attention to what is going on in China. There is a severe risk of inflation there and they will have to do something about it sooner or later. This will not be a plus for world markets when it occurs.

Investors who want to short the markets can use ETFs to do so. To short the Dow, S&P500, Nasdaq 100 and Russell 2000, ProShares ETFs DOG, SH, PSQ and RWM can be used. For aggressive investors who want to take a 200% short position, the ETFs DXD, SDS, QID, and TWM are the respective choices. For super aggressive investors, Direxion offers 300% short BGZ on the Russell 1000 and TZA on the Russell 2000. Alternatively, shorting can be done by going long on the volatility index VIX with ETFs VXX or VXZ.

Disclosure: Long VXX

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Do Conditions Exist for a Fall Stock Market Crash?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Market crashes don't take place overnight. They result from excesses that build up because the market has failed to neutralize them with intermittent bouts of selling. Stock prices always correct and if they don't do so by smaller amounts every now and then, they will correct by bigger amounts later on. While crashes almost always take place in the fall, the possibility that one might occur at that time can usually be ascertained by the condition of the market in the preceding spring.

When there is going to be trouble in the fall, the market should already be showing frothiness around March and April. This condition is currently being met. U.S. stocks have been in rally mode for over a year now without any significant correction. Sentiment indicators are starting to indicate too much bullishness and too much complacency. The most recent Investor's Intelligence poll found less than 20% of investors are bearish. This is a low number. Market Harmonics put/call volume ratio for equities has fallen to multi-year lows and is well into extreme bulllish territory. The VIX (the volatility index for the S&P 500) made a new yearly low of 15.32 today, April 12th, and this is also quite low. All of the aforementioned are contrary indicators and the lower the numbers, the more bearish it is for stock prices going forward.

While the market could certainly be characterized as overbought, the technical indicators I use don't indicate that it is severely overbought just yet, especially on the intermediate-term charts. The stock market indices got to incredibly oversold levels in the fall of 2008 and spring of 2009 and they are still working off this condition. One of the most amazing aspects of the current rally is the lack of volume support for the Dow Jones Industrial Average. Volume peaked at the bottom in March 2009 and has been in a long, slow decline since then. Declining volume on a rally indicates buyers are losing interest. For a rally to hold up for more than a year given this condition is truly amazing.

Some selling in stocks could start any time in the next few weeks, but this would probably not indicate the end of the rally. A break in a market that is already frothy can be patched up and the market can then go even higher. When that happens there is risk of much greater selling a few months down the road. Abundant liquidity is always necessary for this to occur. That exists today just as it did in 1929 and 1987. Other underlying conditions are different however. While the 1987 market was supported by falling interest rates and lower commodity prices, current conditions are just the opposite. Now longer-term interest rates are changing trend and are going to higher levels. Commodity prices,with the notable exception of a number of food commodities, are also going higher. These are negatives in the long run for stock prices. There is also political risk to the markets later this year because U.S. capital gains rates will be raised in 2011. Ironically, the higher the market goes now, the bigger investors' profits will be and the more likely they will sell before the end of the year.

The easiest way for investors to check up on the rally is to watch the VIX. While anything at the 15 level is pretty low, the VIX fell slightly below 10 in late 2006 and early 2007. Macro economic and market conditions are not as supportive now as they were at that time though, so it should not be assumed that these same ultra-low levels will be reached again. The VIX tends to bottom several months before a major stock market sell off as well. It bottomed in May in 2008 for instance and the S&P 500 low for the year was in November. Investors who think the VIX has bottomed can buy the ETNs, VXX or VXZ. This is the same as shorting the market, but is a simpler way of doing it.

Disclosure: Long oil

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This article is not intended to endorse the purchase or sale of any security.