The Market Is Too Dependent On Hopes That Await Evidence

The market remained positive, near its December peak for three months, primarily based on hopes.

·         Economic reports were dismal during the winter and into March, indicating the economy was slowing significantly.

·         However, hopes are that not just some of it, but all of it, was due to the dismal weather, and that reports for March and April will prove it.

·         The economy (GDP) grew only an anemic 1.9% last year, down from 2.8% in 2012. Forecasts for the first quarter just ended are also for growth of less than 2%.

·         However, hopes are that the economy will pick up in this quarter and for the rest of the year, and GDP will average more than 3% for the full year.

·         Corporate earnings growth has been declining for more than a year, and first quarter earnings, now being released, are expected to continue that downward trend.

·         However, hopes are that the first quarter will be the low for earnings growth and it will rebound sharply over the rest of the year.

·         Conditions including valuation levels, overbought conditions, investor confidence, and so on, are at levels seen at most previous bull market tops.  

·         However, hopes are that the market is destined for bubble market conditions like 1997-2000, with the bull market continuing until valuation levels reach the unusual extremes seen at the bubble top in 2000.

At this point, the market needs more than just hopes.

Next week’s economic reports may be key in that regard, since they will provide updates on retail sales, new housing starts, industrial production, and the Fed’s ‘beige book’ analysis of economic conditions in its 12 regions.

Meanwhile, the volatility has spawned considerable talk of bubbles and crashes; either that the market is not yet in bubble conditions so has further to go (usually after several triple-digit rally days); or is due for a vicious crash (usually after several triple-digit down days).

However, both bubbles and crashes are extremely rare events, neither likely to take place.

Only twice in the last 110 years has a bull market’s valuation become so pumped up that analysts referred to it (usually afterward) as having been in a bubble. The first was in the 1920s, which culminated in the 1929 crash. The second was in the 1990s, culminating in the severe 2000-2002 bear market.

Likewise, there have only been three market crashes in the last 100 years, a crash defined as a one or two-day decline of 15% or more. The first was in 1929, when the Dow lost 23% in two days. The second was in 1987, when the Dow lost 26% in two days. The third was the so-called ‘mini-crash’ in 1998, in which the Dow lost 11% in three days.

That is not to say that the market is not at risk of a serious correction or bear market of the type that normally takes place over months or even a couple of years.

Over the last 110 years there have been 25 bear markets, or one on average of every 4.5 years. The average decline was 36%. The ten worst averaged declines of 49.9%.

So obviously, the market does not have to reach bubble conditions before topping out into a bear market, and almost never does.

Meanwhile, although a market crash is not likely, as they are also rare, this week’s sharp market decline of more than 2%, which has the market now down fractionally for the year-to-date, did confirm what I have been saying in this column for several weeks.

As we approach the end of the market’s favorable winter season, with the market over-valued by most measurements, and the Federal Reserve rapidly tapering back the QE stimulus that has been so important to the five-year bull market, it’s time to be prepared to take downside positions in ‘inverse’ etf’s or short-sales when the time comes.

Being a market technician, as always I will depend on technical indicators, and the breaking of important support levels, to indicate when that time has come.

However, risk is already high, while the market’s resilience is still primarily based on hopes.   

********

Sy is president of StreetSmartReport.com and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.