Why You Shouldn’t Be Fooled by the Market

Why You Shouldn’t Be Fooled by the MarketFollowing a weak second quarter, the Dow Jones Industrial and S&P 500 indices are now in positive territory for the first time since the end of the first quarter on the backs of a positive July and August.

So far, August has proven strong for technology, growth, and small-cap stocks, with the NASDAQ and Russell 2000 up 4.2% and 3.4%, respectively, as of the close of Thursday. The S&P 500 is holding at 1,400, a level that I believe will be tough to hold. Every time I look at the long-term technical picture of the S&P 500, I’m concerned about the vulnerability. Since 2000, there have been two major tops at above 1,400, and the current bull market rally from March 2009 appears to be heading for a third top.

What I continue to see is an expectation-driven buying based on a best case scenario that includes a third round of quantitative easing (QE3) from the Federal Reserve, the saving of the eurozone, and strengthening in the U.S. economy. And then you have the uncertainty of the upcoming presidential election.

Yet the reality is that Europe remains in a financial mess, with six eurozone countries in a recession and straddled with major debt and growth issues. Britain is also in a recession. Germany, the largest and strongest economy in the eurozone, is showing positive signs, but the problem will be the country’s focus and distraction in helping to save the eurozone. German Chancellor Merkel appears to be backing the desire of European Central Bank (ECB) to keep the eurozone together, but so far, we have yet to see any concrete evidence of a strategy to do this.

Spain’s bad debt loans accounted for a whopping 9.4% in June at US$201 billion. The country is in its second recession in three years, and there is chaos on the streets, as the country’s jobless rate hovers at around 25% and is even higher for the country’s youth.

The 27-country European Union and 17-country eurozone saw their economies contract by 0.2% in the second quarter, following a flat first quarter, according to Eurostat. Another down quarter in the eurozone will place the region in a technical recession. Economists predict the eurozone’s economy will shrink this year and in 2013.

I still see high risk in Europe, and stalling there will continue to negatively impact China and other key global economies. (Read “Why the Chinese Economy’s Showing More Cracks.”) The market view is that China will be forced to launch a massive program of fiscal and monetary stimulus to drive its economy and avoid a “hard landing.” So far, we have yet to see a major stimulus strategy put in place. The country’s consumer inflation rate fell to a manageable 1.8% in July, well below the historical average of 4.3% from 1994 to 2012, but some pundits believe inflation could edge higher in the fourth quarter to above three percent due to the higher prices for agricultural products.

My suggestion is that you shouldn’t get too ambitious towards the current market. The global risk continues to be quite high and is not going away anytime soon.