Don’t buy the dips. Sell the rallies.

It’s not uncommon for bull market opportunities to be exploited by buying dips in prices.  This is not one of them.

The bull market in equities is at least on pause, but in all likelihood over.  The latest series of down days is further confirmation of a lack of conviction.

There simply aren’t buyers.

Prices will go down farther if buyers don’t step up and buy dips.  This has already been evidenced on a day-to-day basis.  Whether it happens in the weekly charts remains to be seen — but price action seems to be confirming that as of late.

Commodity contagion

Weakness in the prices of energy, metals and other products continues to be a persistent theme.  And equities have finally noticed.

Stocks used to shrug off the losses in commodities as some sort of disinflationary tailwind.  No longer is that the case.  Now investors in stocks have become jittery on days when commodities are plunging.

The next leg down

Ultimately, the equity market is at much greater risk of a price decline than a rally.  The run up over the last 6 and a half years has been overextended.  Price to earning ratios, when share buybacks are discounted, are at higher than normal levels.

Corporations have amassed enormous amounts of debt and traders are speculating with more margin than in 2007 (the last stock market peak).  China has seen its managed economy unravel, while Japan’s attempt to start managing its economy is falling apart.

The Euro zone is in serious trouble.  There’s no amount of new debt that can cure the budget problems within many of its countries.

And the United States, which is starting to feel the pain of the rest of the world, is preparing for its own economic slowdown.  The Fed, panicked with uncertainty as its credibility fades away, decided once again to abstain from raising interest rates.

What does it all mean?

We’re closing in on the peak of this business cycle, if it isn’t already behind us.  This means that opportunities will be few and far between to find equities that are worth buying at these values.  Cheaper prices are quite likely in the future.

If I were still long a traditional portfolio of US equities I would take every rally as an opportunity to reduce exposure and raise cash.

Quick thoughts on 2015

This is likely going to be a year of reckoning for overvalued equities and corporate bonds.  The credit markets have already begun their contraction, but equities hold on to the promise of earnings expansion, while only truly achieving multiple expansion.  Stocks are far too rich in price vs. the underlying economic global backdrop.  I expect a significant correction, and I expect it to occur during (or before) Summer.

Look out below! Market setting up to fall.

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.