Long term OK but Too much Complacency Spells Trouble

Stocks are not cheap, but the Bull lives on credit

Stock market values are based upon the discounted perception of future rates of earnings and growth  primarily. Many fundamental methods are used along with technical analysis to determine periods of over or under value. One tool is adviser sentiment: when too many are positive then there is less investor potential to propel prices higher; the reverse is just as valid. In 2014 long term adviser sentiment has been overbought, fiscal mismanagement has ballooned our national debt past $17 Trillion, margin exposure is at record risk levels and Europe, China & Emerging markets are struggling. Yet our economy has grown for over 5 years without a recession or stock Bear market on the backs of unlimited stimulus.

In spite of these real concerns long term we continue to feel deep corrections in stocks can be bought when considering: Europe and China have yet to stimulate (which will boost emerging markets) and consumer-corporate and banking balance sheets are the best in decades.

The medium term concern is that Bullish sentiment extremes are now at levels last seen at the major 2007 stock market peak and in 1987. Once a truly deep stock market correction occurs  >10% where fear becomes dominant then we can still expect another one to 3 years of rising prices and a positive flow of funds away from Bonds into Stocks.

We still favor a first half of 2014 rally melting into a medium term topping formation to be complete during 3rd quarter 2014 before a mid-term election cycle correction. As is the case when stock prices rise relentlessly without a serious correction there is a growing battle as more investors refuse to Buy new highs yet a growing supply of investor dollars build on the sidelines salivating for a “normal” correction that is difficult to generate with so many buyers anxious to invest. eventually major news events trigger fears of economic concern allowing a larger than normal drop in prices to manifest.

This battle of Buyers in waiting and fear of Buying the Top perpetuates a “running” Bull market that generates many very small corrections and just as many small breakouts to new highs. At some point the battle ends with a larger than expected “abnormal” price correction—perhaps 10 to 25% or whatever it takes to truly scare the majority of investors that finally bought and turn them uniformly negative (Bearish) at the ensuing bottom.

As yields fell under 2.6% Stocks began to fall sharply. Consensus has been unanimous that the global economy would gain strength and that the US would lead the way. The US has led and earnings are resilient. However, as the Global economy slows and US Quantitative easing ceases in October 2014 the US earnings surge will stagnate until Global stimulus returns. Eventually Europe and China will see the error of their ways as their economies edge into recession mode and will then launch a new round of currency printing and fiscal stimulus which will immediately turn Global stocks higher.  The next leg higher in stocks may be led by Europe as their capacity is far more underutilized than the US and while Europe will be adding liquidity the US may be subtracting. The Bull market should have legs higher over the next couple of years, but the 2nd half of 2014 has risk of a course correction.

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