Only Two Sectors Hold up the S&P 500 Index Now

tower of coinsAs the S&P 500 goes higher, I am becoming more skeptical of the stock market rally.

Here is what’s happening. The S&P 500 has risen significantly in the past few months—more than 14% this year so far. I predicted in Profit Confidential several times this past summer that once the Federal Reserve announced the third round of quantitative easing (QE3), the market would rise. That’s exactly what we are witnessing.

But, as I have also said before, there have to be solid reasons for a stock market rally to continue if it is to continue. We had all the reasons in 2009, but those reasons are not valid anymore.

If you look closely at the S&P 500 index, you will see there are few intriguing phenomena occurring that make the stock market rally look rosy; but the underlying reality is that the rise in the key stock indices is simply because of two sectors.

Below is the chart of the S&P 500 compared to the Financial Select Sector SPDR (NYSE/XLF), and the Technology Select Sector SPDR (NYSE/XLK). These exchange-traded funds (ETFs) track the performance of different sectors in the S&P 500.

s-p500

Chart courtesy of www.StockCharts.com

As you will quickly notice in the chart above; the financial sector and technology sector are outperforming the S&P 500 index as a whole—returns in excess of 20% since the beginning of this year.

These two sectors together make up little more than 34.5% of the S&P 500 index. (Source: Standard & Poor’s, October 15, 2012.) In other words, for every one-percent increase in the S&P 500, more than one-third of the increase is due to the financial and technology sectors.

The S&P 500 seems to be showing amazing returns, but if we take out these two sectors from the S&P 500, the stock market rally doesn’t look very impressive at all. The S&P 500 is simply being pushed higher because of these two sectors. It makes sense.

The Federal Reserve’s new QE3 program of buying mortgage-backed securities is helping the big banks immensely. Investors can’t count on earnings growth from old world companies; hence they are willing to buy up the shares of technology companies that might just be the next Microsoft Corporation (NASDAQ/MSFT) or Apple Inc. (NASDAQ/AAPL).

If we take the financial companies out from the S&P 500 index, the overall earnings of the S&P 500 index would fall 5.3% in the third quarter this year, compared to an expected fall of 1.7% with the financial companies included in the S&P 500. (Source: Bloomberg, October 8, 2012.)

With the record amount of negative earnings guidance from big-cap U.S. corporations and with the global economy being in the dumps, the rise you see in key stock indices doesn’t add up and the risks are piling up.

Be careful about that stock market rally, dear reader. As I have been saying all along, it is a bear is sheep’s clothing that will soon reveal itself.

Michael’s Personal Notes:

When I turn on the TV or radio or surf popular financial sites and I hear or read journalists telling their audiences the economy is improving, I can’t help but feel sorry for their audiences.

When I talk to people; all I hear is how their pockets are affected, and even though they are “making money,” their income just disappears into thin air. The fact is that consumers drive the U.S. economy, and currently they simply can’t spend.

Wages adjusted for the inflation rate have decreased 0.3% in September and 0.6% in August. (Source: Market Watch, October 16, 2012.) If you were earning $100.00 in July, by the end of September, your wage was actually only worth $99.10.

At the same time, basic things that really matter to consumers in the U.S. economy are rising in price. The Gasoline Index (index that tracks the prices of all types of gasoline) increased seven percent in September; it has been increasing for three months and was up nine percent in August! (Source: Bureau of Labor Statistics, October 16, 2012.)

While wages continue to fall, and prices for basic goods continue to increase, the Core Consumer Price Index (CPI), a measure of the inflation rate in the U.S. economy excluding energy and food prices, shows an increase of only 0.1% in September, similar to the inflation rate increase in August of – 0.1%.

We all know how good the inflation rate looks when you look at the Core CPI, because it’s an outdated measure of inflation that excludes energy prices and food. Hence, the core CPI assumes people can walk to work and not eat.

The real rising inflation rate is taking a toll on the U.S. economy. The basic point is that if consumers spend more money on food and gas, because both are rising in price, they will have less money to spend on other things.

If you look at gasoline prices compared to gold bullion prices, gasoline prices have gone down since the beginning of this year, as the chart below shows.

gasoline unleaded spot price gold spot price

Chart courtesy of www.StockCharts.com

But when measured in U.S. dollars, the price of oil has been rising, because the more money the Federal Reserve creates, the bigger the freefall for the U.S. dollar against other world currencies, except the euro.

See this chart below, showing the price of crude in U.S. dollars.

gasoline unleaded spot price gold spot price

Chart courtesy of www.StockCharts.com

Dear reader, what we are seeing is a war against the wages and pockets of American consumers. The printing of American dollars is in process and there is more to come. The low “official” inflation rate you see now will become history quickly.

Where the Market Stands; Where it’s Headed:

We are in the very late stages of a bear market rally in stocks that started in March of 2009.

What He Said:

“A low savings rate was eventually blamed for the length of the Great Depression. Consumers just didn’t have enough money to spend their way of the Depression. With today’s savings rate being so low, a recession could have a profoundly negative effect on overextended consumers.” Michael Lombardi, Profit Confidential, March 26, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.