The Market Feels Ready To Crack

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 |  Includes: DIA, IWM, QQQ, SPY
by: Bret Jensen

Summary

The market is celebrating 5 years since equities saw their lows in March 2009.

Stocks have had a huge run over that time but the market is starting to feel "tired" at current levels.

Investors should keep an eye on four potential market moving indicators and plan accordingly.

"It requires a great deal of boldness and a great deal of caution to make a great fortune, and when you have it, it requires ten times as much skill to keep it." - Ralph Waldo Emerson

It has been five years now since the market hit its nadir in March 2009. It has been a great run since then. The NASDAQ is up almost 250% since those lows and the S&P 500 is up ~175%. Not surprisingly there has been a spate of the "market is overdue for a correction" commentary and articles to celebrate the anniversary of the stock market lows.

There are indeed myriad reasons to be concerned as this bull market gets long in the tooth. The overall market multiple is slightly above historical norms and emerging markets (Ukraine, China, Argentina, Turkey, etc.) seem to give investors something new to worry about on a weekly basis.

I am not as worried about the overall market indexes as much as some of the more speculative sectors and stocks that have led the market higher and are now in nosebleed territory as far as valuations are concerned. It is these sectors that could turn on a dime and give investors some significant pain even as the overall indices deliver modest declines.

As these levels the market just seems tired and ready to crack driven by big pull backs in the momentum names. Here are my four biggest worries on the current market.

#1 - The Federal Reserve

It is hard to go into the reasons why we have had such a massive rally over the past five years without talking about the actions of Federal Reserve. As Barron's has pointed out a few times over the past few months, over 90% of the stock market's moves has been directly correlated to Federal Reserve actions. Investors should remember that the conclusion of both QE1 and QE2 hastened double digit declines in equities before a new easing program was announced from the Federal Reserve to stem the bleeding.

By ~quintupling its balance sheet since the beginning of the financial crisis the Fed has successfully driven asset inflation in both stocks & real estate. This has been great for the 5% to 10% of the population that holds the majority of these assets.

Unfortunately, these actions have not driven economic or job growth in the ways expected. Both are posting the weakest results of any of the ten post war recoveries. Given the acrimony between the two political parties and numerous anti-growth policies of the past five years this is not surprising.

So if GDP growth has only been bumping along at a 2% level while the Federal Reserve provided extraordinary support; what will it be going forward when the Fed is done with pumping liquidity into the market? One only need to look at emerging markets since the Fed started the "taper" talk in May or to the conclusion of QE1 and QE2 to be alarmed of what this could mean for the stock market over the coming months as the Fed continues to withdraw liquidity measures in $10B increments.

#2 - The Smart Money is heading for the exits

One of my biggest concerns is that the "smart" money is cashing out and heading to the exits. 2013 saw the busiest IPO calendar in nine years and 2014 is operating at an even faster clip in the New Year through February.

Founders, venture capital players and private equity owners are accelerating their push into the public markets. This was highlighted last year by the huge $20B offering for Hilton Worldwide (NYSE:HLT). Hilton was taken private in 2007 right before the markets started their descent into the financial crisis. Could its return back into public hands be a sign the bull market is nearing an end?

It is important to remember that the market saw IPO activity surge in the late 90s and in 2007 just before the emergence of the crashes that followed.

#3 - The Dumb money is re-entering the market

Coinciding with the "smart" money starting to head for the exits is the return of the retail investor; the so-called "dumb" money. In 2013, U.S. stock mutual funds and exchange-traded funds saw an inflow of $172 billion, the highest amount since 1992, according Lipper. Retail investment flows tend to be a great leading indicator of turns in the market. The average investor unfortunately tends to buy High and sell Low as it just seems to be a law of human nature.

#4 - Momentum stocks are starting to reverse

Individuals who believe that "bubbles" no longer exist in the market as investors have learned the hard lessons dished out in previous debacles should check out the following three month chart of two of the darlings of the "Alternative Energy" sector, Tesla Motors (NASDAQ:TSLA) and Plug Power (NASDAQ:PLUG), below. It is something straight out of the internet boom in my opinion.

(click to enlarge)Click to enlarge

Chart Source: Yahoo! Finance

The biotech sector which is up roughly 75% since the beginning of 2013 has also entered bubble territory in my belief. Although this pales in comparison to the 3D printing space where players like 3D Systems (NYSE:DDD) and Stratasys (NASDAQ:SSYS) have tripled over the past two years with little in the way of earnings.

Curiously, these sectors have started to sell-off over the past week or so. Investors should keep a sharp eye on this development as it could portend a major crack in the momentum names that have been a huge part of this rally if it continues.

(click to enlarge)Click to enlarge

Chart Source: Yahoo! Finance

Conclusion:

Every investor has to make their own decisions in regards to investing strategy and risk profile. After 2013's ~30% rally which was accomplished despite an only 5% rise in earnings, I am cautious here as I see potential signs the market is starting to crack a bit.

I am carrying higher than normal cash balances waiting for a lower entry point. I have also sold just out of money calls on some of my more aggressive holdings such as biotech for lucrative premiums. Last year was the time for "greed", this year is looking like "caution" is the better course of action.

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