Stocks pulled back after a big advance and that can be good for bull markets
Most of the bricks in the previous wall of worry have been removed.?Economic reports have continued to improve over recent weeks; in manufacturing, the service sector, retail sales, durable goods orders, and even in the employment picture, where 151,000 new jobs were created in October, more than double the 70,000 that economists expected.
The uncertainty over the Federal Reserve’s QE2 decision has been resolved with the Fed adding to the stimulating atmosphere, providing another round of quantitative easing in spite of the already improving economy.
The major U.S. market indexes, including the Dow, S&P 500, and Nasdaq rallied back to, and then above the potential resistance at their April peaks, before pulling back some this week.
Investors have become even more bullish and optimistic. This week’s poll of its members by the American Association of Individual Investors showed 57.6% bullish, the highest level in almost four years.
The good news apparently also reached Main Street. On Friday morning it was reported that the Thomson Reuters/University of Michigan’s Consumer Sentiment Index improved to 69.3 in early November (its highest level in five months) from 67.7 in October.
So what has been wrong with global markets this week?
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The U.S. market closed down roughly 2.5% for the week. Emerging markets, which many analysts projected would benefit the most from inflows of additional liquidity provided by the Fed’s decision, were down the most. Brazil, India, South Korea, closed down two to three percent for the week, while China closed down a big 5.5%. Meanwhile, Japan, a large developed country, which was not supposed to fare as well as emerging country markets, closed up 1.0% for the week.
A bet against emerging markets via the ProShares UltraShort Emerging Markets ETF, symbol EEV (designed to move up when emerging markets move down, and leveraged two to one) closed up almost 9.0% for the week.
Was it just that markets had become short-term overbought and ran into a brief bout of profit-taking, particularly since this was the week before the month’s options expirations week, and the week before tends to be negative?
If so, markets are likely to be back up next week since the decline this week took care of the short-term overbought condition, and next week is the week of the expirations, which tend to be positive.
Or was the decline the beginning of something more serious?
The market does seem to have a new wall of worry just a week after concerns about the economic recovery, and whether the Fed would or would not provide additional quantitative easing, faded away.
The bricks in the new wall of worry include:
- Concerns that the Fed’s additional stimulus may cause new problems rather than help the economy by encouraging home purchases or providing new jobs.
- Worries that commodity prices had spiked up into bubbles which may burst, a worry that struck Friday with the big $40 an ounce (3%) plunge in the price of gold, and equally large declines in the price of oil and other important commodities.
- Apprehensions about the activities of the Chinese government, including talk that it might hike interest rates to dramatically slow its globally important economy and ward off threatening excessive inflation in China.
- Anxiety about a potential currency or trade war if the decline in the U.S. dollar continues.
Via technical analysis there is also the U.S. market’s intermediate-term overbought condition above 20-week moving averages, and the high level of investor bullishness (which is at levels of complacency often seen at market tops).
The uncertainties have even extended to U.S. Treasury bonds, which investors have piled into as a perceived safe haven over the last two years. The safe haven over the last two months has actually been a bet against U.S. Treasury bonds. For instance, the ‘inverse’ ProShares Short 20-year bond etf, symbol TBF, designed to move up when bonds move down, has gained 11% since early September, while bonds have declined 11%.
There’s no doubt about it. We are still in a very fluid economic and investing period, not a time for investors to become so complacent as the investor sentiment readings seem to indicate, that they fall asleep at the switch.
(In the interest of full disclosure, we have positions in the U.S. market, the Japanese market, gold, and the ‘inverse’ bond ETF TBF, in our portfolio, at least at the moment).
