Anyone closely following major market indicators as they race towards new highs in the last twelve months cannot help but notice two alarming signs investors must have been ignoring:
Major Equity Indexes
Five-day Performance (%)
3-Month Performance (%)
12-Month Performance (%)
SPDR S&P 500 Trust (SPY)
Powershares QQQ Trust (QQQ)
SPDR Dow Jones Industrial Average (DIA)
The first sign is the lack of rotation. Cyclical and non-cyclical stocks continue to rally, as money is plentiful. In the last three months, for instance, two highly cyclical stocks, Ford (F) and General Motors (GM) have gained close to 13 percent, while two non-cyclical stocks P&G (PG) and McDonald's (MCD) have been following closely behind.
The second sign is a slowing world economy. Most European countries are in recession; the U.S. is barely growing -- though there are some positive signs, e.g., an improving labor market, even mighty China has slowed down substantially, though it has eased monetary policy twice this year.
The third sign is investor complacency, as evidenced by the low volatility index (VXX). This means that investors are reluctant to buy insurance to protect their investment portfolio for the prospect of a correction, as they got used to central bankers providing such insurance. The trouble, however, is that there is only so much central bankers can do to protect investors from reckless decisions. Another round of QE, for instance, may cause another round of commodity price spikes, depressing consumer spending, while an additional debt-financed fiscal stimulus could cause a spike in interest rates. Besides, last time investors placed too much faith in policy makers was in early 2008, that's when markets peaked.