As the S&P 500 hovers within striking distance of all-time highs and seems poised to either break out of a huge multi-year range to new highs or sink back after making a triple top, we should look to some major indicators for hints as to the strength of this phase of what has been a powerful bull market.
Monetary Easing: The Federal Reserve continues to provide massive monetary stimulus. Chairman Ben Bernanke indicated in his testimony to lawmakers over the past couple of days that the Fed policy would continue to be easy into the foreseeable future.
For the last couple of years it has been rather obvious that the actions of the Federal Reserve have fostered and propelled this bull market. Clearly, monetary easing has been a huge boon for this bull market in equities, but at some point there could be elements of diminishing returns from the Fed actions.
Seniors who have saved are not receiving any significant interest income which puts stress on their retirement portfolios, many of those portfolios were modeled on a 6% interest rate, as the norm. Also, the support of commodity prices while wages stagnate is another long-term problem that monetary easing contributes to. This is evidenced by the huge rise in food stamp rolls--now over 47 million. These types of imbalances tend to find their way onto the government debt and deficit rolls as social programs are forced to expand to maintain a basic form of social cohesion.
Currency Flows: The U.S. dollar has been strengthening over the past few weeks against most other currencies. The Dollar Index (DXY) has moved from about 79 at the beginning of this February to about 82 as of now.
The EUR/USD cross shows a significant increase in USD strength in the last month.
The U.S. dollar has strengthened dramatically against the Japanese yen over the last few months.
Generally speaking, a strengthening currency, in this case the U.S. dollar, is a headwind to higher equity prices.
Bonds: There has been lots of talk in the financial community about a "great rotation" of money in U.S. Treasury Bonds flowing into stocks, which should push equity markets higher. However, there has not been any significant weakening in the bond market. Over the last couple of weeks bond yields (which move inversely to bond prices), have gone down.
GDP Growth: While the 0.1% GDP growth rate in the 4th quarter of 2013 could be an anomaly, involving factors such as hurricane sandy, it is not a positive indicator for the equity markets.
Wages: If we are going to have an inflationary environment (even 2% per year, which is the Fed target), wages will need to rise to propel growth. As it is wages are fairly stagnant.
Labor Force Participation Rate: Rather than use several of BLS unemployment rate statistics, such as U3 and U6, I have chosen the this because it appears to be the most accurate representation of the amount of people in the workforce. A steadily falling labor force participation rate (currently 63.6%), is not a positive indicator for the stock markets.
Declining stock market volume has been a very puzzling factor for many in this multi-year rally. While it clearly has not affected the ability of the markets to move higher, it should not be ignored.Click to enlarge
Volatility: Historically, the Volatility Index (VIX) has been viewed by many as a market direction indicator. When the VIX is high, the market is generally near a bottom and when the VIX is low, a market top may be close. However, the VIX has been in record low territory for the last several months and the markets have continued a spectacular run higher.
In my view, some of this disparity may be accounted for in the volume chart. Since the VIX is a function of options prices and general stock volume is down, the VIX may be affected by low stock volume in a round about manner. Seemingly low VIX levels may be skewed by low stock volume.
Conclusion: As we look over most of the indicators of economic growth and activity, it is clear that the Federal Reserve's aggressive monetary easing action is the stand-out factor of what has been fuelling the equity market's bull run. Without the Fed's actions, equity markets would likely be in a very different place.
The question at hand is; Will the Fed's continued easing be sufficient to propel this market, that has seen amazing gains, yet higher through massive technical barrier territory?
As we have seen with most of the indicators shown above, there is not much real economic power at present to push the market higher. However, there are so many market participants expecting a downturn that the market may trade sideways for weeks or even months before a significant downturn is seen.
My view is that if the S&P 500 keeps moving up at the current rate with no significant correction, even if it was to make it past its all-time high of 1576, the move would not be likely to last without a significant change for the better in many of the fundamental indicators we discussed above.
As we wait to see which way it goes I would consider purchasing VIX futures, which are available through several ETFs.
(NYSEARCA:VXX) is the most popular, by volume.
(NASDAQ:TVIX) is a levered VIX ETF. Please note; levered ETFs are designed for short-term trading.
Disclosure: I am long VXX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am short the S&P 500 via long-term options (SPY).