We have seen gradual signs that Mr. Market is tiring and in need of a rest. A 12% run-up of the S&P since January 3 is a sprint not equaled very often and a pause would make sense. Our technical indicators also show the beginnings of some selling based both on world economic problems and natural profit taking. Nothing about the future is ever perfectly clear but markets never go straight up and corrections are frequent reminders of this. Interest rate spreads between Treasuries & junk bonds are extremely narrow as well indicating complacency about risk in lower quality assets and that stretching for yield has reached extremes. We are wary of high yielding ETFs, closed end funds and bonds as all are trading at prices at or above all time highs. As mentioned above, Ben has been unsuccessful in getting our economic engine to run on paper & hot air and this, in our opinion, will be his 3rd try at testing his fuel of choice. We expect that this attempt will not prove to be the charm but if we're wrong and things get better through the fall one of the unintended consequences will be a more virulent rise in domestic inflation. This will change his plans dramatically and force a tightening of interest rates. Rising rates will then derail any nascent recovery. This will be exacerbated if the President somehow convinces Congress to raise tax rates.
We said in our opening rant of 2012 that the odds of a good start for stocks were high but we now see clouds gathering and are watching our indicators for confirmation that a trip to the sidelines is in order.
The mid-week rally occurred at the 50 day Simple Moving Average. On cue, the computer traders whose algo- driven systems are programmed to defend specific price points kicked in and we got back some of the recent losses but Friday's action fits the scenario in which we expect a short bounce followed by further selling. This would also square with our theory of at least 1 more Fed test failure and at least a 20% pullback. Unfortunately for our Ben, he is nearing the end of his tether. Rates will be difficult if not impossible to lower from here without a major explosion in food & fuel costs. We have little faith in the efficacy of his plans anyway but we believe it is entirely possible that things could get out of hand and the Fed could lose control of the situation. Watch this space.