Why the Stock Market Is Running on Nothing But Thin Air

Why the Stock Market Is Running on Nothing But Thin AirSince June of this year, the Dow Jones Industrial Average has gained about nine percent. Meanwhile the S&P 500 and NASDAQ have gained about 11% each.

I recently wrote about a possible “triple top formation” on the S&P 500 chart and how technical analysis suggests that the key stock indices might be heading south. I dug a little deeper and found what I believe is more evidence the S&P 500 is bound to go south.

Sucker’s rally! Bear trap! What do they have in common? They lure people into believing that the economy and stock market are doing well so investors are enticed back into buying stocks. Keep in mind that near a market top, investor confidence is high and the ‘buy now or you will miss it’ greed factor is very convincing.

Technical analysis would suggest that there is “triple top formation” in the S&P 500 chart (see: “Beware “Triple Top Reversal Pattern Almost Complete”), but there is more to it.

On Wednesday, August 15, 2012, the volume of shares traded on NYSE totaled 2.64 billion. This is roughly 29% below this year’s average. (Source: Market Watch, August 16, 2012.) Stock market trading volume has been suspiciously weak all of August.

When key stock indices climb higher or turn sour, there is lots of participation—more volume, not less. The current rally looks to be running on nothing but thin air.

Can volume alone prove the recent rally in S&P 500 and key stock indices is a bear trap? Of course not. But there is more…

Short interest (a measure to gauge professional investors’ sentiment about certain stocks or a market) in S&P 500 futures by commercial traders (banks and investment firms) has been rising sharply. The professionals are betting the market is headed lower.

The rising short interest by commercial traders in S&P 500 futures is something that should worry small investors like you and me. Either these commercial traders are trying to protect their positions or they are simply trading the S&P 500 futures for gains.

Since 2005, when short interest (betting the stock market will go down) activity is greater than long interest (betting the market will rise), we’ve witnessed a subsequent downturn in the markets. Currently, short interest is rising and long interest is falling.

The increase of short interest in S&P 500 futures is suggesting that the sentiment of commercial traders seems to be changing towards bearishness. Don’t forget; they are big banks, funds and firms that invest significant amounts of money in the markets—they can’t afford to be wrong.

Dear reader, there is enough evidence out there to give credence to the theory the current rally in S&P 500 and other key stock indices is nothing but a sucker’s rally. The sentiment by big banks and funds is quickly turning towards bearish territory. As I reported yesterday, stock advisors (who are amateurs) are increasing their bullishness on stocks—a contrarian indicator.

Trading volume is extremely low—there’s not a lot of market participation. Are the S&P 500 and other key stock indices going much higher? I have reasons to believe they won’t.

Michael’s Personal Notes:

Even the most amateurish of an economist knows consumer spending increases when consumer confidence is high. Unfortunately, the current dire state of the economy has taken a toll on both consumer spending and consumer confidence.

Recent reports show that the U.S. birth rate has plummeted to a 25-year low. The birth per woman in 2007 was 2.12 children. It has now fallen to 1.87—a decrease of 12% in five years. (Source: Daily Mail, July 26, 2012.) The main reason for this: bleak consumer confidence in the economy. As a good friend of mine likes to say, “No money, no funny.”

What got my attention about these just-released statistics: during the current economy, the birth rate has fallen to a level below the birth rate of the Great Depression.

The number of children was 2.3 per family on average in 1933, according to U.S. Centers for Disease Control Prevention. (Source: Bloomberg, August 21, 2012.) Could consumer confidence be so weak that people are hesitant to make decisions that can lead them into more financial distress?

In general, when the population increases, consumer spending rises. Similarly, when consumer confidence is high, consumers spend more. The birth rate affects sales of thousands of products and services in the economy…not only diapers and food, but also others items such as housing and education.

Consumer confidence today is bleak. Parents are not having kids at the rate they used to, because it can be costly. According to U.S. Department of Agriculture, a middle income family having a baby in 2011 will spend about $234,900 over 17 years on that child for food, shelter, transportation, and child care.

American companies are complaining about families not having children like they used to. The CEO of Kimberly Clark Corp. (NYSE/KMB) said that the company is “feeling the full effects of three years of low birth rate declines.” (Source: Bloomberg, August 21, 2012.) Kimberly Clark makes diapers and training pants.

Now to back track a bit, I have been writing about the high unemployment rate and its negative effect on consumer confidence. Though it abolishes consumer spending due to low disposable income, it may also discourage people to start a family, buy a bigger car, or buy that bigger house with more green grass.

There are more hurdles in boosting consumer confidence. The cost of tuition is rising. More students are in debt, and when they graduate, they have student loan payments to make. With the job market in the doldrums, it discourages consumer spending and slumps consumer confidence.

The economy is showing more and more reasons to go against those politicians and economists who say “we are seeing economic growth.” This economist only sees the economic situation getting worse.

High unemployment and skyrocketing student debt were enough on their own to push consumer spending lower. But the current decline in the birth rate is another big long-term economic negative. It not only illustrates just how weak consumer confidence is, but also helps us predict future consumer spending—which doesn’t look good right now.

Where the Market Stands; Where it’s Headed:

Taking a break from my regular rant on the stock market, I wanted to share this excellent quote from NRH Research’s just released 2012 Ranking of Gold Mines & Deposits:

“…a gold mine or deposit is an asset no different than a farm, commercial property, or financial security. Yet when it comes to gold, there are only 439 assets that meet the industry perceived economic threshold of 1 million ounces. Last year, we compared this figure to the tens of thousands of commercial real estate properties in the world or the nearly 72,000 financial securities. While the crustal abundance of gold is fixed, and discovery grades continue to decline, there is no limit to the creation of financial securities and plenty of land and building materials to construct more property. Simply put, a gold mine or deposit with over 1 million ounces is a very rare asset.”

There are only 439 gold mines in the world with deposits equal to one million ounces or more of gold. Of those 439, only 189 are currently producing gold. Food for thought if you haven’t already gotten into the 10-year old gold bull market yet. (See: “Why the Bull Market in Gold Bullion Is Far From Over.”)

What He Said:

“Over the past few weeks I’ve written about subprime lenders and how their demise will hurt the U.S. housing market, the economy and the stock market. There’s no escaping the carnage headed our way because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom that peaked in 2005, have yet to arrive.” Michael Lombardi in Profit Confidential, March 22, 2007. At the same time Michael wrote this, former Fed Chief Alan Greenspan was quoted as saying “the worst is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”