What the Current Trading Action’s Signaling

economic newsI think stock market investors need to be extremely cautious going forward this year. There’s been good price momentum so far in 2012, but the economic news is still lackluster. The stock market’s been going up because of the Federal Reserve, decent corporate earnings, and reasonable valuations. This can only take share prices so far; eventually, the economy is going to have to produce some real growth or investor sentiment will quickly turn.

Last year, the stock market started out strong, and then experienced a hefty correction. It recovered, but was not able to break out of its trading range. Eventually, share prices dropped off a cliff, as investor sentiment was shaken by the sovereign debt crisis in Europe. Only now is the stock market barely above where it was last April and I think we’re due for another change in the price action. (See Trading Action Repeating Itself—What the Stock Market’s Setting Itself up for.)

Investor sentiment changed for the better at the beginning of this year as if the stock market was tired of worrying about the eurozone. Trading volume has been mediocre at best and, while the main stock market averages have gone up, the lack of volume is telling. I expect a stock market correction to occur soon. Commodities could be hit as well.

This is why there is absolutely no rush or great call for individual investors to take on new positions in this market. Investor sentiment is still decent, but investment risk in equities continues to be very high and a conservative portfolio stance is warranted. I would be a new buyer of dividend paying stocks in this kind of market environment, but only after a price correction occurs. While valuations are still reasonable on a historical basis, I don’t see how corporate earnings will be able to accelerate when you have slow growth in the U.S. economy and no growth in Europe. Earnings multiples should be lower than usual in the age of austerity.

This year, the stock market has so far displayed good resiliency, as investor sentiment went positive. Even in the face of less than inspiring economic news, share prices ticked higher. I do have the sense that this positive trading action can continue, but not much longer without some much better Main Street data. And I’m not talking about “confidence” data. I mean real economic growth. Investor sentiment has proven to be more fickle than usual over the last 18 months and you need to be prepared for it to change on a dime.

 The stock market has gone up and so have the spot prices of gold, silver and oil. All these important assets have their own reasons for their price moves, but everything is vulnerable to a correction now. Investor sentiment is holding, but it is fragile. The correction could happen next week, next month or in the bottom half of the year. I’m not sounding the alarm; I’m just reading the stock market’s current signals.