With the last legs of this rally really more of a sideways trade on very light volume, we’re starting to see some signs that a rolling over process has begun. While there is plenty of reasons to be a bear, the most compelling reason to be a bull was the notion that things were getting worse at a slower pace. The idea was that we overcorrected to the downside in March, facing what appeared to be a depression, and having (at least temporarily) taken that off the table, we see very attractive valuations.
We’ve had a nice run already
After about 40% off the bottom, I think we can say the valuations have gotten ahead of themselves. In addition, there are no signs of an earnings-led recovery or any real green shoots that indicate we’ll be seeing a pronounced rebound in the economy. Most of the optimism is coming from China, which seems to be hoarding commodities for its own hedging game against the falling US dollar. While hunger for raw materials is good for the markets, if it is not a genuine appetite that stems from growth, but rather a desire to build a materials portfolio for the Chinese government, then much of the optimism in energy, materials and other related sectors is overdone.
The biggest driver is not behind the wheel
The consumer is facing more foreclosures, credit card defaults and an increasingly tight employment picture. This is not the atmosphere that is condusive towards a consumer-led recovery. Consumers probably have 5-10 years before they can start to lever up again on their credit. Other emerging markets are attempting to build consumer economies, and facing tremendous headwinds from populations who treasure thrift rather than spending. The appetite for material possessions is not nearly as strong nor are earnings per capita elsewhere enough to sustain the vacuum left behind by the American and European economic implosion.
Greenflation not back, yet
Green energy is a promising sector when crude oil is above $100. Right now the motivation is just not as strong with consumers or companies to make big moves in to more environmentally sustainable energy. I believe that once inflation makes energy less affordable the appetite for green energy will increase. This may be a while off depending on how fast the global economy can pick up the slack left behind from the last bubble.
Climb a plateau once its peaked…
So where is the catalyst for the next rally? What could drive equities higher? The only way we’re going to see a tremendous rally from here is if we see much more currency debasement and intentional inflation. That kind of manipulation could continue to lead markets higher, but at the cost of the currency that equities are priced in therefore nullifying much of the gains.
Or fall right off?
I think the market is setting up to fall. I’m not so sure we’ll retest the lows or not, but I do think we’ll see some more selling as fundamentals begin to play a center role in the stock market again. On a technical note, we may be building a pretty significant head and shoulders pattern on the S&P 500. Today’s action seems to confirm the right shoulder. We could see a retest of 875 or lower if it continues to play out.