Posted on: Thursday, December 8, 2005
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Market Looks Toppy

   
 
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The stock market looks increasingly vulnerable at this time.  The quality of the rally that started in early November was mediocre as it exhibited tepid volume, a declining number of new highs, an increasing number of new lows, and poor breadth.  Over the last couple of weeks the market has been much stronger at the opening than at the close, an occurrence that has often preceded weakness in the past.  Now a number of the oscillating-type indicators such as stochastics and RSI indicate that the market is overbought and starting to tip over.  Sentiment is particularly exuberant.  The percent of AAII bulls as a percent of bulls plus bears recently ran up to 78%, a level associated with at least short-term market declines.  The VIX measurement of volatility remains at low levels, indicating a lack of fear.  Apparently favorable news from Texas Instruments that used to jumpstart stocks to big daily gains was completely ignored by the market today. 

 

All of this is happening at a time when the leading indicators of economic growth are deteriorating despite the ballyhoo you see in the media.  Real consumer spending declined in August and September and was up just 0.1% in October.  We don’t make this stuff up—it’s the statistics reported by the Government, although you’d never know it from following TV and the press.  In addition, housing is definitely showing signs of weakening with today’s comment from Toll Brothers only the latest in a series of disappointing data.  And although the year over year price appreciation of Nationwide home prices have increased about 12%, prices have dropped over the last two months.  Also two well recognized economic entities (Macro Economic Advisers & Anderson) have just this week predicted that a peak in home prices has been reached.  Since consumer extraction of cash from the previously soaring rise in home prices accounted for an important share of the growth in consumer spending, a weakening housing sector has exceedingly negative implications for the economy in the period ahead.

 

Fed comments and speeches also make it highly likely that the FOMC will hike rates 25 basis points in each of the next two meetings starting with the one next week.  That is far more important than all of the discussions you hear dissecting every word of the FOMC statements.  History strongly suggests that by the time the Fed stops tightening, the forces leading to a recession and bear market have already been set in motion, and we see no reason why this time will be an exception.  This is particularly so at this juncture when we consider the record trade imbalance, the federal budget deficit, the extremely low consumer savings rate and the immense burden of record household debt.  When we also consider that the market is selling near the high end of its normal P/E range, almost all of the indicators we use to gauge the potential market direction are pointing downward.

 

 

 

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