This Bubble Will End Badly

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

Our macroeconomic and earnings-based assessments tell us that the Dow Jones Industrial Average (DIA) is in a bubble, and every bubble in recent history has ended badly. The Internet Bubble was followed by wealth destruction, and many of us can still feel the pain of the credit crisis. This bubble we are in today will end just as badly as those.

The EPS growth of the Dow Jones Industrial Average has been 0% for the past two quarters, revenue growth has been negative, and the earnings analysis offered by Stock Traders Daily tells us that this is a major concern because during that same time the price of the Dow Jones Industrial Average has increased aggressively. It has increased without EPS growth, and with contracting revenue.

During a time when EPS was under pressure, the Dow has increased, and normally one might argue that the market is a leading indicator, everything was going to improve, and the discounting mechanism that is the market was simply ahead of the curve, but in this case we know a few things that makes that a cloudy assumption to say the least.

The economy is finally coming under pressure from the austerity programs that started at the beginning of the year. That means GDP levels are not good, the deficit and debt problems our country is facing will be a material headwind and dampen economic activity for quite some time, and the prospects for accelerated growth in the Dow actually look unpromising. This would be true based on an assessment of earnings expectations as well; there is just no expected growth either, and then we could add in a Federal Reserve who is openly talking about removing stimulus.

If these are true, then why is the Dow increasing?

The answer has everything to do with fear and greed, the two nemesis of every market cycle. Larger investors have leveraged their investments by adding margin debt, spreads are now near 2000 and 2007 levels when compared to S&P 500 (SPY) prices, and the momentum in the market has smaller investors clamoring for fear of missing the run. The end result has created another in a series of asset bubbles.

Not unlike every other bubble we have experienced over the past 15 years this will end badly, but the question is when. For that, we look for signs, and here is a tell that might help some investors with timing. On Monday the markets recovered after an early loss, the Dow was quite strong, but the 2x VIX ETF (VXX), which one would expect to fall when the market is strong, actually increased instead.

When coupled with the longer term technicals offered by Stock Traders Daily, the tell starts to make complete sense, and a turn down indeed appears imminent. The difference is this turn is happening from bubble-levels that are akin to 2000 and 2007, and that means the fallout can be much worse than anyone is expecting.

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

Business relationship disclosure: By Thomas H. Kee Jr. for Stock Traders Daily and neither receive compensation from the publicly traded companies listed herein for writing this article.