The Investment Rate Warns Of A Major Market Turn Down

Includes: DIA, QQQ, SPY
by: Stock Traders Daily

This is the third time the market has been at these highs since 2000. We saw these levels in 2000, 2007, and now in 2013 these same highs are being tested. The S&P 500 peaked near 1520 in 2000, it peaked at about 1560 in 2007, and here it is again at those same levels in 2013. After each of the last two peaks the market has turned down aggressively too, so another logical question is if that process will repeat itself as well. After each of the prior two spikes the S&P fell to about 800, wiping out significant wealth for not only the wealthiest 1%, but also for investors of all types, retirement plans, and college savings accounts that were heavily invested in the markets.

Market returns since 2000:

· DJIA: about +20%. SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA)

· S&P 500: about 0%. SPDR S&P 500 ETF Trust (NYSEARCA:SPY)

· NASDAQ: about -20%. PowerShares QQQ Trust, Series 1 ETF (NASDAQ:QQQ)

Rolling back the clock and taking a closer look at the prior two peaks reveals something extremely important as well. A strong expectation of substantial market increases existed at each of the peaks, expectations were running high, and the market and the economy were in bubbles. Those bubbles are rarely obvious to the masses before they begin to burst, but in hindsight we know that the Internet Bubble caused the market to spike to near 1520 in 2000, the Credit Bubble caused the market to spike to near 1560 in 2007, and we know that the unwinding of those bubbles is what brought the market to its knees in between.

Therefore, the logical question about the future concerns the existence of a bubble at these market levels like there were the past two times. In addition, if there is a bubble, how might that bubble be unwound is a relevant follow-up question, because after all the pain is not felt until bubbles actually burst.

In consideration of the macroeconomic conditions that exist, and with particular attention paid to The Investment Rate, which is the most accurate leading longer term stock market and economic indicator I have ever seen, two material truths exist. First, according to the Investment Rate, the market is in a natural state of weakness based on demographic trends that are similar to both the Great Depression and stagflation, and there is nothing anyone can do to stop that. That is a material fact, and although we do not know if the market will fall or the economy will weaken because the government has been spending aggressively to offset it, we do know that the second of these two important material truths also holds true. With all of the spending and the entire stimulus, the economy is still weak.

Reasonable men will ask themselves why this is true, because the levels of these spending programs and capital infusions has been unprecedented, and actually should have had a much more material impact to the naked eye, but the Investment Rate explains exactly why it has not, and the answer lays in the root of all long-term economic cycles, and the foundation for economies in general, people.

As sure as death and taxes, we cannot stop the influence of demographic trends, but since the meltdown in 2008, the government has done a good job offsetting it. Looking back at the prior to market peaks and in an attempt to answer the question pertaining to bubble conditions, we also can reasonably surmise that if the government had not spent and stimulated to the extent that it did, the economic environment that exists today would look much different than it does now. One might also surmise that if the government stops spending and stimulating that the trend could reverse.

With that I will leave it up to you, and everyone else who reads this article, to decide if this condition warrants the definition of a bubble, knowing that hindsight is always 20-20. In my opinion this is indeed a bubble, but this bubble is much worse because the declines in the investment rate become much worse after 2012. That means the natural rate of growth is declining, but the market has been increasing, and that entices smaller investors back into the game. Nothing is the matter with investing, so long as risk control is a major priority, but problems exist for buy and hold investors from these levels. Over the past 13 years anyone who bought at these levels without controlling risk found himself 50% underwater a couple of short years afterwards.

Reasonably, those declines only happened because the bubbles burst, and it would take quite a bit to have the government stop stimulating and spending, but here is a little-known fact that I have documented for my clients. As of today, right now, the net stimulus infused by the combination of fiscal and monetary policy has changed from net stimulative to a net drain on liquidity. Officially, even with the $85 billion bond purchase program announced by the FOMC, the net drain on liquidity is about $5.2 billion on a monthly basis. I will also let readers determine if they think that constitutes the first sign of a bursting of the "stimulus bubble" that we are in today. I believe it is a warning that should be heeded.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Written by Thomas H. Kee Jr., President and CEO of Stock Traders Daily. Neither he nor Stock Traders Daily receive compensation from the companies mentioned herein for writing this article.