Stock Market Bubble?

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The market made a solid rally up to and through its resistance levels. More importantly the indexes closed strong. I was asked, what gives? There was bad economic data (jobs), the majority of S&P companies are lowering forward guidance, there are continuing problems in Europe, we have our own fiscal issues, etc. Why is the market rallying? That is a good question. The answer lies in the fact that the supposed free market system is being heavily manipulated. Traditionally, investors have a decision to make; invest in bonds and/or stocks. We purchase bonds when the interest rates move higher and we start purchasing more stocks when the interest rates fall and the economy looks stronger. However, one side of this equation has been heavily manipulated, the bond market. The Fed has not only fixed interest rates at close to zero in order to keep interest rates low, but they are also buying bonds (now over 80% of the entire bond auction market). This has made the stock market the ONLY place to invest, regardless of fundamentals or technical views. Is this a stock market bubble?

Stock Market Bubble?

The Rally and the Bears
The parade of professional investors and traders that have been interviewed on CNBC and other financial networks and media are concerned that, from either a fundamental or technical analysis view, the market is due for a correction. Fundamentally, the economy remains weak. Technically, between the VIX and other indicators, the market should see some type of pull back. However, one must throw traditional measuring tools out the window, because you can’t fight the Fed. They seem to be warning of a stock market bubble

Call this rally a “Fed Rally” or “Wall of Worry Rally”, either way it is all the same. Yesterday’s strong rocketing rally came on the heels of the FOMC Minutes, which stated the Fed will continue its course and do WHATEVER IT TAKES to get the economy going. Despite the handful of Hawks expressing concern about the Fed’s ever expansive balance sheet or the ramp up of inflation, it is the Doves that rule the nest. The Fed doing “whatever it takes” sparked a small rally and then by mid-morning we started to see massive short-covering. Those fundamentalist and technical traders got caught short and start capitulating, which only created a stronger rally.

The Hawks remind me of that handful of individuals like Congressman Ron Paul, economist Nouriel Roubini, and others that warned us about the housing boom. We started hearing the concerns in late 2006, but they were called “fringe”, “radical”, “silly”, and all kinds of words. The Fed had stated that there were NO PROBLEMS in the housing market. When problems started to surface, the Fed again stated that it was only “Sub-Prime”. When the watershed movement was about to happen, the Fed said it was “contained” and the banks were fine. The Fed and Congress, which is trusted to oversee the system and to regulate it, were wrong from the beginning. They failed. Bubble
It was the same when I lived back in San Francisco during the rally and the first big stock market bubble. My friends deeply involved in the industry were all talk about the “new economy” and that if you didn’t get it, you were an idiot. Business models and revenue were a thing of the past; it became all about obtaining “web traffic”, “aggregated eye-balls”, and all kinds of nonsense. The few naysayers were called idiots, including Warren Buffet, who at the time was deemed by many as not understanding the “new economy”. Buffet concluded, correctly, if the math doesn’t make sense it will eventually fail.

So here we are; the market has rallied far beyond what the fundamentals and technical analysis deem appropriate, is this another stock market bubble? The VIX, a measure of premium or perceived market risk, is at levels lower than before the housing bubble crash, pretty much the VIX is saying – there is NO RISK. The Fed has now stated that money printing and zero interest rates are pretty much here to stay and they will do MORE to keep this going.

Fed inflates the bubble
Did we forget that low interest rates under Allen Greenspan help spur the housing boom with cheap money? What makes Bernanke’s almost FREE money (zero interest rates) any different?

No doubt a bubble is building, just look at the math and balance sheets. The Fed’s balance sheet is expanding at over $1 trillion per year and the Federal government’s is doing the same. I am not sure what will be the catalyst event and I don’t think the Fed can easily start unloading trillions of debt back into the market (debt that no one would buy in the first place). I do know that right now, you can’t fight the Fed and the equity market certainly has room to go higher, despite economic weakness. The market is rallying, not because of strong fundamentals or technical analysis; it is rallying because the Fed is herding investors into it and out of treasuries. But is this a stock market bubble?

As I am frequently asked, when will this bubble burst? I don’t know. What I do know is that the math doesn’t make any sense. The answer to the question is when there is no one left to buy. All bubbles burst… eventually.

Bubbles - stock market bubble

Beanie Babies
I remember riding to work on the bus in San Francisco and seeing people lined up at 5am in the morning in front of a store. I couldn’t figure out why, they didn’t look homeless waiting for a soup kitchen to open. One day I got off the bus early and walked over to find out why all these people were waiting in line. They were waiting for the store to open to buy Beanie Babies. When I talked to these people they all seemed like they were in some mass hypnosis or a cult. They were excited and charged up, looking for the illusive rare Beanie Baby that could bring $100s of dollars. I felt like I was in some absurd fantasy, could these people REALLY believe this? They did, because they were in line at 5am in the morning with a hand full of cash to buy a toy. When I walked to work I started thinking about these people; they reminded me of Lemmings. I noticed that same look in the eyes and hypnotic talk from my friends in the industry. The same thing happened during the housing bubble. I knew people buying 1500 square foot homes built in the 1950s for over $1 million dollars, thinking they would go to $2 million. When I hear Paul Krugman speak that our debt and deficit spending is NOT a problem, he too sounds like one of those people inline waiting to buy his Beanie Baby. The same thing seems to happen in every stock market bubble.

Beanie Babies - stock market bubble

Are we there yet?
Is this happening again? I don’t think we are there yet. For the most part there are still a lot of people calling for a correction and the fundamentalist / technical people are still not on board with this rally. We need them to fully capitulate and then we need the shoe shine boy or kid working at the coffee shop to give us a stock recommendation, thus marking the lowest rung on the ladder of buyers. Perhaps it will be Cramer from Mad Money that will tell us to buy everything.

While we certainly could go higher, the signs are there that this market is fighting the forces of fundamental nature and the VIX is at scary levels. But where else is there to invest?

This is NOT a stock market bubble, it is a BOND and DOLLAR bubble! When this bond/dollar bubble burst it certainly will bring volatility to the equity markets and could certainly bring the stock market down. However, just like the housing market bubble, the stock market sold off because of the need for cash and leverage being reduced. There were some segments in the stock market that did fall with direct links to housing (banks, construction, etc).

Now I speak of the market in its entirety and from a West perspective. I still remain bullish on the emerging markets and their growth, but not all companies participate in that arena and many of those companies are not listed on the US exchange.

Jobless Claims
The weekly jobless claims saw a rather huge drop of 42,000 to a “seasonally adjusted” 346,000. Of course, the previous high week was revised higher by 3,000. Economists did expect a drop, but not that much, they felt that it would fall to 365,000. The interesting thing was the non-seasonal adjustment moved up to 353,973. The disparity in the move with the new method to the “seasonal adjustment” is just getting wider. They are no longer moving in tandem. So were the last few weeks an anomaly? Perhaps, but the Labor Department did change the model recently and we can see, through factoring in the adjustments and revisions, that there are more questions than answers. The data didn’t give the market too much to go on and it looks to be a flat opening.

INDU 14,800
I thought we would see some resistance at 14,700, but with the short-covering we blew right through that level and up to the 14,800 area. I am not sure how much follow through we will get this morning. I would look at the trending range of 14,500 – 14,800.

NDX 2800
We blew through that level and it could very well become the new support area. If we get a pullback in the next few days, look at 2800 as possible support. If it holds it means we could be breaking out of this sideways trend in this tech heavy index.

SPX 1580
I mentioned yesterday that we could get a jump up to 1580 intra-day, but I didn’t think we would hold above it. We did and that means I would look at 1570 as short-term support on any pullback. The VIX is back in the low 12s; that is just too low in my book.

RUT 950
The broad-based market has been lagging. It also doesn’t have the level of short interest in both equities and futures that the S&P does. So far it is not breaking into new record territory and that should be a slight warning sign that this recent rally in the narrow index could be getting a little ahead of itself. I would watch the 950 level closely. If the RUT falls back to the 920 level, I suspect we could start to see a pullback in the other indices.

When Dove’s Fly

The Doves and Keynesian rule the day. The Fed will continue to print money, QE3 is has been declared infinite in time and money, the Vice-Chairmen, Yellen, has applauded Japan’s massive money printing devaluation, the Doves have indicated they will do whatever it takes, and that means that the Fed money printing and zero interest is here to stay for a long time.

While I am neither a Democrat nor Republican, I do hope that Republicans can maintain control of the House. The Fed is now leaning more and more Keynesian and Dovish, thus championing the money printing policies and zero interest rates. If the Democrats regain control of both houses in the mid-term elections we could be in for some huge monetary changes, taxes, and worst of all uncontrolled, unchecked deficit spending and a level of debt of which there is no safe return.

Regardless if you feel the Fed’s policies are right or wrong, don’t fight the Fed. They have a printer, we don’t!

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