Given a slowing economy in China, the continued credit crisis in the eurozone, and the worst post-recession recovery in U.S. history, one would think the S&P 500 has been rallying in the wrong direction.
This year alone, the S&P 500 has gone up 17%. The index fell to its record low of 676.5 on March 9, 2009, in the midst of the U.S. financial crisis after the fall of Lehman Brothers Inc.
The chart below of the S&P 500 looks even more dazzling. We see the S&P 500 breaking the 1,400 level and rising quickly above that level. Seeing this chart, one would think, “Run, catch the bull before it moves too far ahead…economic growth is back and everything is back to normal.” Unfortunately, this is far from the truth.
Chart courtesy of www.StockCharts.com
Don’t let a prolonged dead cat bounce fool you. We can see a dead giveaway just by looking at the chart above. Look at the lower part of the chart; those red and black bars. Notice that, as the S&P 500 index has been rising, trading volume has been declining. True bull markets rise on increasing trading volume, not declining volume.
The S&P 500 climbing higher doesn’t necessarily suggest that there is economic growth in the U.S. economy. Far from it.
Could it be that the recent highs made by the S&P 500 are simply because the Federal Reserve has tuned the speed of its printing press higher? You bet that’s the reason the market has gone higher.
The S&P 500 has never stayed above 1,400 when the unemployment rate was high—which is what it is currently faced with in the U.S. economy. When the index reached the 1,400 mark in 1999, the U.S. unemployment rate was only 3.8%, and in 2007, when S&P 500 reached above 1,500, the unemployment rate was still below five percent. Sadly, the unemployment rate has been above eight percent for last 43 months in U.S. economy.
If we look at corporate insiders, they’re not buying stock; they are dumping stock in companies they work at. (See “Corporate Insiders Dumping Stock at Alarming Pace.”)
If we look at stock market advisor sentiment, it’s going the wrong way, too. Stock market advisors, whose opinions are usually wrong, are more bullish now than at any other time since May of this year. The Dow Jones Industrial Average dropped 1,000 points starting in May of 2012.
Finally, corporate revenues at the S&P 500 companies are declining. We may end this current quarter with corporate America experiencing negative revenue growth. Whenever this has happened in the past (negative revenue growth for the S&P 500 companies), a recession has followed. (See “Negative Revenue Growth for S&P 500 Companies Signals Recession.”)
As an example of big companies cutting revenue and earnings growth, FedEx Corp (NYSE/FDX) cut its profit forecast for its fiscal year 2013. The main reason for its cut in forecast was simply a weak and slowing global economy. (Source: Reuters, September 18, 2012.)
Dear reader, don’t get lured into the hype about the S&P 500 making new highs. Optimism is the highest when the market is near its top—the greed factor looms. After bringing some facts into the picture like I have above, the recent hike in the S&P 500 becomes very questionable.
The municipal bond market is not a safe place these days. Municipal bankruptcies are becoming a norm in the current U.S. economy, and bankruptcy is the only way out for many municipalities.
Local governments have to control their budget deficit—and deficit cuts are much needed by municipalities in order to avoid any future disturbance with creditors. The after-effect of local governments taking the usual steps to stay alive will be on the municipal bond investors—a $3.7-trillion market.
Cities in California, like Vallejo, Mammoth Lakes, Stockton, and San Bernardino, have already defaulted on their municipal bonds. Compton is most likely to be the next to default. What do all these towns have in common? They are suffocating under big budget deficits.
When times are good, spending doesn’t seem to be a problem. For example, Bell—a city just outside of Los Angles—revealed in 2010 that it paid city managers $800,000 a year. (Source: Wall Street Journal, July 18, 2012.) This kind of behavior is what gets municipalities in trouble.
Cities that filed for bankruptcy were facing immense budget deficits. Property taxes are the main source from which municipal governments get their revenue. When that tap is turned off, cities must find other ways to earn revenue to pay their dues—or simply tell municipal bonds investors, “Sorry, we can’t afford to pay you.”
It may sound like a perfect plan: default on municipal bonds and start over. I must ask the question, is it working? The answer is simply, no.
The cities that have already defaulted on their municipal bonds are still scrambling. Stockton, California wants its municipal bond insurers to take a bigger hit because it has pensions to pay—$26.0 million each year. The insurer of the municipal bonds stands to lose more than $100 million. (Source: The Examiner, September 17, 2012.)
Similarly, Jefferson County in Alabama is showing distress, once again. This county filed for chapter-nine bankruptcy back in 2011. The municipal bond insurers are now feeling a bit skittish and could lose about $709 million. The city failed at financial planning and controlling the budget deficit.
The moral of the story is that the number of municipal bankruptcies is going to increase and the municipal bond investor will certainly be affected by it. The issue of cities defaulting on municipal bonds is not only in California. Municipal bond investors need to be very alert about what it is they are buying. Don’t let the temptation of tax-exempt bonds lure you in.
Wenatchee, Washington, Scranton, Pennsylvania, and Moberly, Missouri have already skipped on their municipal bonds payments due to a lack of cash. (Source: Bloomberg, September 10, 2012.) Who is next? There will certainly be more.
Where the Market Stands; Where it’s Headed:
There’s not much I can say about the stock market that I already haven’t said above except for this:
Since 2009, the government and the Federal Reserve have fought the bear market tooth-and-nail. The government has gone on a borrowing spree never before seen in history. The Fed has increased the money supply by trillions—money out of thin air. And interest rates have been kept artificially low for years.
In the end, I believe all the meddling by the government and the Fed will only act to delay the inevitable and natural forces of the bear market.
What He Said:
“For the economy the message from retail stocks is quite clear: Consumer spending, which accounts for roughly 70% of U.S. GDP, is in jeopardy. After having spent like ‘drunkards’ during the real estate boom years, consumer spending is taking the same trend as housing prices, slowing down faster than most analysts and economists had predicted. As news of the recession continues to make headlines in the popular media, the psychological spending mood of consumers will continue to deteriorate, lowering earnings at most high-end retailers and bringing their stock prices down even further.” Michael Lombardi in Profit Confidential, January 28, 2008. According to the Dow Jones Retail Index, retail stocks fell 39% from January 2008 through November 2008