The Market Should Get A Gut Check Soon

by: Markos Kaminis

The broad market indexes are trading at multi-year highs today, but the macroeconomic environment is deteriorating at the same time. Stocks have likely benefited from the gradual pace of deterioration globally, versus how far and fast they would fall in a panic stricken economic slide. That is evident in the performance of the "fear index," the Volatility S&P 500 (VIX), which is trading at about a five-year low. Equities are likewise benefiting from hope, however false it may be, in the Federal Reserve, European Central Bank (ECB) and other central banks globally. Thus, I expect an inevitable gut check is in store, and most likely within the next two months.

The Dow Jones Industrial Index and the Standard & Poor's 500 Index are trading at 4-year highs today. The SPDR Dow Jones Industrial Average (NYSEARCA:DIA) is up 10.4% year-to-date into Tuesday's trading day, and the SPDR S&P 500 (NYSEARCA:SPY) is higher by 15% this year, each after accounting for dividends and splits. The PowerShares QQQ (NASDAQ:QQQ) has gained an astounding 23.5% on the year, supported by the gains of Apple (NASDAQ:AAPL) and others (Apple marked a record high Monday). This is in a period in which Europe fell into recession and remains in financial peril, as China's economic engine slows and as the U.S. economy bears the weight of it all. It is, thus, counter-intuitive.

Stocks have certainly been fueled by the survival of the European monetary union, which would seem to have escaped some of its toughest challenges. The Vanguard MSCI Europe ETF (NYSEARCA:VGK) has recovered since its June trough, and even the Global X FTSE Greece 20 ETF (NYSEARCA:GREK) reflects cautious optimism. But the EU's issues are likely to reignite chaotic concerns with yield costs to bear, as sloppy austerity cuts into the budget balances it is meant to restore. So as local economies defy recovery, Greece, Spain, Portugal, Ireland and Italy are likely to continue to demand attention from increasingly unwilling partners. And as those partners experience their own taste of the disease that will contaminate the union through to its core, greater and greater commitment will be demanded. The likely outreaches of the ECB and concessions of the so far unwilling will be reassuring to investors, and provide lift from time to time. But eventually, the true picture will be better understood, and it will either provide an illustration of ruination or of triumph.

In a controlled environment, I would say triumph is entirely possible. However, we have a complex environment with all sorts of challenging dynamics to deal with. When China and Russia stand counter to action against a Syrian regime that is rejected by its own people, there is a problem in the global equation. When a war with Iran is undertaken in the tight quarters of the Persian Gulf, with a counterpart who is capable of anything, control cannot be maintained. Disruptions to order cannot be adequately accounted for by the chess players at the Federal Reserve, ECB, nor in Washington D.C. When the market realizes this, one way or another, a gut check is in store.

When those days dawn, investors will be served better by stakes in counter-plays and hedges including the ProShares Short Dow 30 (NYSEARCA:DOG), the ProShares S&P 500 (NYSEARCA:SH), the ProShares Short QQQ (NYSEARCA:PSQ), the iPath S&P 500 VIX ST Futures ETN (NYSEARCA:VXX), the ProShares Ultra VIX Short-Term Futures ETN (NYSEARCA:UVXY) and the VelocityShares Daily 2X VIX ST ETN (NASDAQ:TVIX).

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.