Market Outlook: Downside Risks Dominate

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Includes: DIA, QQQ, SPY
by: Sean Hannon

I rarely watch CNBC. With a format that relies upon constant analysis throughout the trading day, the network tends to make mountains out of molehills. The majority of the time, set agendas dominate careful analysis and irrelevant items gain great prominence as each expert attempts to explain every change in stock price and pontificate upon every minor market move.

These words may be harsh, but they are not intended to be an indictment upon the network as a whole. When it comes to major events, CNBC is a must-watch as its guests usually do an excellent job of dissecting key trends. Therefore, when I learned that the economy had shed an additional 20,000 jobs during January, yet the unemployment rate had declined to 9.7%, I reached for the remote.

Unfortunately, CNBC's usually reliable trend analysts fell short this time. After listening to the various pundits offer fuzzy explanations, I came to my own conclusion-no one has a clear view of the future. We know that the recession has eliminated over 8 million jobs and the economy remains weak. However, some view those lost jobs as permanent, while others believe robust growth in the first half of 2010 will drive job growth. Some believe government intervention in the markets will lead to a successful handoff to the private sector, and others think the constant meddling has only delayed the inevitable. As I sat in front of the television, parties with vested points of views made their arguments and reached little consensus.

I have always been intellectually closer to those who feel wealth cannot be created by printing more money and that the strong growth in asset prices was a reflection of excess liquidity instead of a forecast of future growth. For now, the stock market is confirming that view.

Relatively good news on the economy and earnings fronts has been overwhelmed by fear. Furthermore, a market that remains oversold cannot rally. When the Dow Jones registered back-to-back triple-digit gains to start the week, I saw no improvements in the market internals. In my weekly commentary, I warned that this was a pause before a further decline, and as prices unraveled last Thursday that view was confirmed and my timing model dropped to 24% long (20% long is officially oversold).

On Friday the market was unable to reverse course, and we now find the Dow flirting with 10,000. Although 10,000 offers little technical significance, it holds great psychological weight. With the economy uneven and recovery weak, a dramatic drop that leaves 10,000 behind will devastate investor morale and set up additional downside.

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