I am trying to put an article together after having the worst food poisoning yesterday in 30 years. Don’t know if I am fully lucid yet, but it seems to me that waiting for a significant pullback is very much like having some bad food that you know that is going to turn into food poisoning. You go through an initial analysis, then just hunker down and try to survive to fight another day. Using that analogy, what could cause a significant pullback over the summer? Here are a half a dozen candidates.
- Silver’s over 25% plunge in the last week or so should disabuse anyone of the theory that this market is driven strictly by supply and demand as well as valuation. A 25 percent plunge in a commodity with no real news smacks of a high degree of speculation. Given the excess liquidity provided by QE2, a good portion that ended up in commodities and high beta stocks, is it surprising that one of the key destinations of this liquidity takes a major hit as the prospect of the withdrawal of that liquidity approaches? Oil and other commodities took significant hits; is this the start of something major?
- The market rally Friday petered out as a rumor circulated that Greece was thinking about pulling out of the euro. Personally, I don’t think this is any more than a trial balloon to put pressure on the EU to improve the Greek bailout by extending maturies and/or reduce the interest rate. It did remind everyone how fragile the situation in Europe is, and how it could cause high volatility and/or a significant selloff at any time. There does not seem to be any way Europe can ride this out to 2013 to give its banks time to build up their capital where they can take the “haircuts” that must eventually happen. Any earlier restructuring has the potential to majorly rattle the markets.
- Despite a decent April jobs report, employment growth is still challenged, at best. The four-week jobless claims average has significantly crept up recently and unemployment has ticked up to 9% again. Hardly the robust job growth needed for a self sustainable recovery, especially considering the rest of an ineffective federal stimulus runs out by the end of the year.
- The housing market is totally moribund and is likely to remain so in the short- and medium-term. One major reason for our slow economic recovery is that the construction industry continues to suffer. The financial crisis was caused in part by easy credit policies that caused overbuilding, and that has led to a deep and continuing fall in construction spending, which is unlikely to change soon.
- Oil’s plunge last week is welcome and will lead to lower gas prices over the next few weeks. However, gas prices have breached a $4/gallon level that changes consumer behavior for at least the short term, and should lead to reduced consumer spending over the summer. I spent almost $70 yesterday to fill up my 15-gallon tank, something you do take notice of.
- Earnings beats are running at the lowest levels of any quarter since the bull market began. I think there are several reasons for this: Comparisons are getting much tougher every quarter; inflation is starting to impact input costs and reduce operating margins, and is likely to continue to be a short- and medium-term trend, given all the prices increases in the commodity complex; and If the dollar continues to strengthen, given the problems of the euro, overseas sales will contribute less to the bottom line as well for multinational companies.
I believe it is about to get very rocky over the next few months. Keep a good amount of cash on hand. Still concentrate in safe, blue chip stocks with reasonable valuations and good dividends like Microsoft (MSFT), Abbott Labs (ABT), Telofonica (TEF) and PPL. Avoid the high beta stocks that have moved significantly beyond any reasonable valuation, like Salesforce (CRM), OpenTable (OPEN) and VMWare (VMW). Also be alert, as it is likely that something not on this list will trigger the selloff. In my case, it was something I did not initially consider: The potato salad.
Disclosure: I am long MSFT, ABT, TEF.