Bad Ending for a Strong Week

The market continued its strong rally this week, albeit on tepid volume. Prior to Friday, the S&P 500 and the NASDAQ had been up 12 of the last 14 trading days. The Dow and NASDAQ have also been up nine of the last 10 weeks! Pretty impressive! So far this year the market has finished up or positive for the day 64% of the time. Historically that number is closer to 50%. This is akin to a coin toss -50 / 50. Does that mean that there will be some reversion to the mean or are things different this time?

As the market continued its climb higher, the volume continues to weaken. That is not the usual pattern of conviction for a market setting consecutive 52 week highs – week after week. It leads me to believe that some form of extreme manipulation is taking place. It is statistically impossible for a market to put in so many new highs on such low volume without something being amiss.

If one examines the history of the Dow of which we have more than 100 years of data, you would find that at any given point in history, the markets trended higher on higher volume. Especially if it was putting in a series of new highs.

Now we have allegations of fraud against Goldman Sachs. Banking has been the business to be in since the bailouts. The Feds are providing banks with virtually free money and instead of lending this money out, they are simply pumping up the markets, setting up for another monumental correction. Or they are buying longer dated Treasury bonds, further out the yield curve and keeping the spread.

The largest six American banks now have assets that are equal to 63% of U.S. GDP; let that figure sink in. The Top 6 banks are also involved in over 80% of the derivative trades and make up a high percentage of the daily volume of activity on the stock exchanges. Weren’t banks created to lend money and help business grow? So why are they using this money to trade the markets?

Overall American business is still terribly slow but inventories have been depleted to the point that shortages are occurring. Statistics show that revenues and earnings are up dramatically from 2009, but are still off, for most industries, about 30% from the peak. This year over year growth data is being spun by focusing on the one year data and conveniently ignoring the fact that most business are still way down.

The National Federation of Independent Businesses (NFIB) issued its March survey Tuesday morning. Optimism in the small business community fell again. It dropped to a nine month low of 86.8. The last time it was at this level was April of 2009. Small businesses produce more than half the GDP and provide nearly 70% of the private sector jobs. Usually we see small businesses leading the way out of recessions since they’re the first ones to see the consumer come back, but what’s happened this time is the consumer still hasn’t come back.

The bottom line is this: outside of banking, no one is all that busy and prices of materials are literally skyrocketing. That smells like stagflation to me. Anyone who tells me that there is no inflation on the horizon is probably not paying that close attention and could be in for a shock.

The S&P 500 broke above the 1,200 threshold again this week. Twice for that matter – once up and then down again on Friday. It may be worth noting that the first time the S&P pierced this milestone was back in mid-2005. The quarterly trailing EPS for the market was $75 then. If we take the consensus estimate for Q1 ($18) and tack on the prior three quarters from last year, then the trailing EPS as of now is less than $65. So what we now have is a market that is overvalued by at least 15%, based on the profit fundamentals from 2005 when we had a stronger, more predictable economy.

So the question is, when the music stops, will you have a chair to sit on? The market won’t go on like this forever. We are overdue for a meaningful correction. Maybe it started today – maybe it is still a few months out. Is your portfolio properly prepared? Do you have an exit strategy?

Ask yourself this, do you want to be emotionally satisfied or financially sound? As far as the indexes are concerned, the danger out there is that of nobody seems to believe this market can ever go down. That thinking is dangerous. Markets can fall faster than they go up. We witnessed a preview of that on Friday, when it dropped quickly accompanied by high volume. In the end it’s not what you make, but rather what you keep that counts.