Does a Contracting Economy Mean Stocks are in Trouble?

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What some people call an economic recovery I really call a controlled recession or maybe even a controlled depression. With all the QE (Quantitative Easing) done by the Federal Reserve, the economy appeared to give us some fake growth for a while (all facilitated by the Fed) but now appears to be in a contraction mode once again. Or at least we can say, the pace of economic growth has contracted based on recent and trending downward economic reports. That being the key, it is contracting rather than expanding. What else can you really expect with all the domestic and global issues abound? Having said that, the optimistic cynicism is getting so bold and strong, that the talk is now; poor economic news does not matter to the price of stocks. Granted, one piece does not matter but the cumulative affect should and does in my opinion. What are stocks suppose to do, go up in poor economic times as well as good? Ben Bernanke, Federal Reserve Chairman is at the controls and he says yes! He wants to drive stocks higher to give us the feel good/rich effect in hopes of spurring economic growth to create more jobs. Sorry, it’s not working and won’t!

Time For A Stock Market Decline?

I think so! I have been warning our members of ProfessionalStockTraderLive.com for over a month, the higher stocks go the more cautious I will become. Of late, I have been saying, the longer they hold this stock market together and not allow it to correct, the more fearful I become of a flash crash or a crash crash occurring. Crashes are rare events and typically happen in oversold conditions. I firmly believe the Fed has been the creator/facilitator of this stock market rally and is maybe not directly, but indirectly trying to keep stocks up and prevent the stock market from breaking key daily and weekly support levels; SPX 50 day SMA 1328, 100 day SMA 1316 and SPX 20 week SMA 1320. If support levels are broken on a daily and weekly basis, do not be surprised if there is a vacuum under this stock market. Whether we get a break down this summer or not, either way; the market is destined for further problems.

I understand pundits and the main stream media spin the economy in recovery mode and site numerous reasons why stocks should go higher. What they don’t care to tell you is, whatever economic pickup we have seen over the last year or so has all been induced and facilitated by the Fed and their easy monetary policy, i.e. (Quantitative Easing) QE 1, QE 2 and most likely, a QE 3 down the road or maybe they might even call it a different program to hide what they are really doing. As for the stock market, anyone who thinks this unabated move for the last 2 years should and will continue without any meaningful corrective action is probably smoking something they shouldn’t be, or merely talking their book (stock positions). The unfortunate thing is, the main stream media will continue to hype per the big Wall Street firms for a higher stock market until they cannot. I do get it, stocks are nominally off their highs by just a few percentage points, so why not continue with the hype? I do believe the sharp sell-off we witnessed in commodities a few weeks back is a preview of what is to come in the stock market. I do not wish to fight the Fed’s (easy money policy) or the 3rd year of a Presidential Cycle indicator which is typically up, but I cannot look the other way in good conscience and not consider the following:

Technical Points To Look At:

  • Internals of the stock market are rolling over and deteriorating
  • Summation index never confirmed the move to new SPX 1370 highs, less participation
  • Monthly SPX rolling to sell signals
  • Froth and exuberance, LinkedIn IPO was to debut at 45, opens at 83 and rallies to 122+
  • Insider selling has picked up; signals concerns by CEO’s and belief of excessive stock prices)
  • VIX (volatility index) nearing yearly lows

Domestic Issues To Contend With:

  • Housing is pitiful and in double dip territory; will be well into 2012
  • Mortgage crisis is still imploding; more and more defaults being reported with no end it sight
  • Jobs picture is stagnant at best; a sign there is no real economic pick-up
  • States have shortened duration for unemployment benefits; they don’t have the money
  • State & Municipal debt crisis still to unfold; derivatives are linked to them which can create an even larger problem
  • Troubled banks = 12%of all federally insured banks; this never gets talked about; another sign of trouble brewing

Global Issues To Contend With:

  • Greece is going broke; collateral damage will be felt around the world; effects are really unknown
  • Italy & Portugal have some serious debt issues to contend with as well
  • Spain, let’s not forget them, they too could be in serious trouble
  • An EU Commission several weeks back said, EU banks were vulnerable and there was rollover risk in the sovereign debt markets; sure sounds like they know how bad things are
  • Moody’s places 14 British Financial Institutions on review; Moody’s confirms how bad things really are
  • Euro-zone manufacturing numbers reported last week are at 7 month lows
  • Fitch downgraded Belgium last week and fears of a Belgian bank being in trouble are beginning to surface
  • China’s economy is slowing down; latest PMI reading last week was worse than expectations; China is trying to prevent an asset bubble
  • Moody’s places Dubai Bank on review
  • Japanese radiation fallout much worse than they reported; milk levels in Hawaii 400-2400X above recognized safe levels

Interesting Issues To Think About:

  • U.S. breaches the Debt Ceiling Monday May 16, 2011. Consider that “solvent” nations simply don't do that. I do believe Ireland did that when they went broke. Isn't the plundering of pension funds a desperate act of the extremely insolvent?
  • Can the real economy keep us with asset prices? I say no! If that is the case, than stocks should sell off. Balance sheets of big hedge funds and financial institutions could be severely damaged and this could exacerbate the selling.
  • Last week, JP Morgan and Goldman Sachs both cut Q2 GDP estimates.
  • Goldman Sachs lowered their target last week on the SPX to 1400 from 1450; a polite way of saying “sell”, without really saying it.
  • Japanese and international tracking sites on the radiation fallout have been taken off the internet. Why? Is it far worse and spreading more than anyone is telling us? Iodine 131 detections are moving towards North American as is Xenon 133; very disconcerting developments.
  • China has the lowest U.S. debt holdings since September of 2010. What is that signaling? Is PIMCO (joking) advising them?
  • Higher input costs and supply issues from Japan could stifle profits to a degree; earnings down grades are more than likely to come.

Conclusion:

With QE 2 about to end, the global growth story in question, domestic trends pointing towards economic contraction not expansion and far too many stresses on the world; I think the stock market is set-up nicely for some meaningful corrective action. Of course, there will be a QE 3 down the road but more than likely not until the Fed allows a small dose of deflation to seep into the economy and thus, has a favorable political backdrop to bring on QE 3. Even if we have a small dose of deflation, prices of goods in the U.S. will continue to rise, giving us “stagflation”(no growth with rising costs).


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About Brian Paragamian

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