I will be first to say that this is a difficult market to play, and it’s certainly full of stock market risk. On one hand, the Dow Jones Industrial Average eclipsed a new record last week when the blue chips index surged to an all-time new record high of 14,413, easily blowing away the previous mark of 14,164 achieved on October 9, 2007. But my trading sense is telling me that we may be close to a near-term top.
I’m not trying to scare you, but do you really think the Dow can advance 42% this year? I doubt it, unless you believe the Dow will reach 18,607 by the year’s end. This figure is based on an annualized return of 9.9% year-to-date. This alone indicates stock market risk.
In my view, the rally in the Dow has been overdone. After trading just above 8,000 a few years back prior to the most recent bull wave that resulted in the current record high, this only adds to the stock market risk.
While I like records, I wonder if the Dow deserves this one. While the big U.S. companies are faring better, the growth is nowhere close to what we saw prior to the Great Recession in 2008.
The reality is that the pumped-up stock market may have more to do with the excess liquidity that is being pumped into the monetary system by the Federal Reserve and central banks around the globe—which adds to the stock market risk. The low interest rates translate into low-yielding bonds, unless you’re willing to take the risk to invest in Spain, Italy, Portugal, and Greece. This is the interest rate dilemma and a major reason why stocks, especially the dividend-paying Dow stocks, are faring so well; but it’s also the reason for all of this stock market risk. What happens when interest rates begin to creep higher?
The high interest rates will wreak havoc on the average American who is carrying significant debt and is just managing to make the minimum payments due each month.
And then there are the $1.2-trillion sequestration budgetary cuts and the automatic $85.0 billion in annual budget cuts, which will have a widespread negative impact on the economy and will add to the stock market risk. But let’s be honest; the country’s money printing presses must stop, and America must deal with its own austerity measures now, or we will end up leaving this burden to our future generations.
Now, we still haven’t even considered what would happen to the stock market risk if the eurozone recession worsens or if China cannot pull out of its stalled gross domestic product (GDP) growth. I sense the market is underestimating the major debt and growth situation in Italy and the muted growth in Germany and France. (Read “Why Eurozone’s Problems Are Headed for America.”)
And then there’s also news that consumer inflation in China has risen to 3.2%, beating the three percent estimate. The problem in China is that the new government’s strategy to drive consumer spending to spur economic growth will add to the inflationary pressures and overall stock market risk.
So you can see that everything isn’t so rosy, and this is why I don’t feel the stocks are deserving of their multi-year highs. It’s currently a speculator’s market, full of stock market risk; so you better be careful and not chase stocks higher. Instead, use put options as a hedge against a possible sell-off.