- Many large cap stocks are not making new highs like the SPY. This is a worrying sign.
- Interest rates have to rise in the future which will put downward pressure on the stock market. Veteran trader Steve Jakobsen believes we could drop 30% from here.
- Oil seems to have bottomed and oil has the potential to make the whole commodity sector rally along with it.
The S&P 500 (NYSEARCA:SPY) has broken through the physiological number of 2000, and commentators and speculators alike are predicting higher highs from here. I am ultra short on this market but it is becoming increasingly hard to predict when this market will roll over in earnest. Investors who are short the market are really hurting right now, and it takes a brave investor to stay short in this environment. Nevertheless, the risk is all to the downside so an investor must stay extremely nimble if profits are to be made. Let's explain why.
First of all, even though the market is making new highs, there are many large cap stocks that are not participating in this move. Look at the General Electric Company (NYSE:GE) to see how far it is below its all-time highs.
Also because we have extremely low interest rates, corporate earnings are inflated. Bonds and stocks have rallied hard for the last few years as these markets have been the benefactors of the US's low interest rate environment. Nevertheless, interest rates one day will have to rise. When they do, investors will start shifting their money back into fixed term savings accounts. Bonds trade inversely to interest rates so when rates rise, bonds will come under pressure. The problem with low interest rate environments is that they can create asset bubbles. I believe we have one forming in stocks, in bonds and in certain real estate markets globally. In London, for example, property prices may rise by 30% this year which is unprecedented in a struggling global economy we have nowadays.
Veteran trader Steve Jakobsen believes that we could see a 30% drop in the S&P 500 from these levels. Jakobsen believes that equities is the only asset class that hasn't been really affected from this ongoing global financial crisis. Therefore, he believes one day the S&P 500 will revert to the mean which could be as much as 30% lower than where we are now.
Finally, I like the movement oil is making at the moment and I think we have finally found a bottom. See chart below.
As you can see from the chart, the spot price of light crude oil has gone from $108 in June to a rising $95 at the moment. The bottom seems to be in and if oil can rally from here, I believe it will put pressure on the stock market as funds will start to leak into the commodity markets. Oil has the potential to take the whole commodity complex with it when it's in bull mode, so depressed agricultural commodities such as Corn and Sugar should also benefit. As you can see from the chart below, commodities have struggled as a whole in the last few years as equities have rallied hard.
Yes, equities and oil can rally together and have done so up to January 2013 since 2008 (practically everything rallied once the Fed ran their printing presses) but since January 2013 oil has not participated in the move. Once the Federal Reserve eventually ends all stimulus programs (either voluntarily or by demand), I have no doubt capital will start leaking into the commodity markets and oil. Also if geopolitical tensions in Iraq and the Ukraine escalate, oil will spike and the world stock markets will decline sharply.
To sum up, there are enough warning signals to warrant not being long here in the US stock market. If you still think the rally is not finished, I would advise scaling down your position size.