The Makings of a Classic Bear Market Trap

key indicatorIt makes for great headlines, as mainstream media tells everyone about the S&P 500’s impressive run. For the first quarter of 2012, the S&P 500 rose 12%. The S&P 500 is now just seven percent away from its all-time high.

As I’ve been writing, this rise has come without the participation of the retail investor, which is us, dear reader. Now, historically, it is always the retail investor that participates last in the bear stock market rally trap, before Phase III of a bear market takes hold and drives stocks lower. So I urge my dear readers to heed this warning.

The retail investor was severely burned in 2008, which is why he/she is hesitant to jump back into this stock market rally and the S&P 500. What usually happens is that, as the S&P 500 continues to rise, the retail investor believes he/she is missing out on a great opportunity to earn high returns, and so finally capitulates and buys, at the worst possible time.

As I’ve been highlighting on these pages day after day, the economic reports that have been released recently are not as rosy as the headlines would suggest.


The housing recovery has still not materialized. The average American’s real disposable income has not appreciated—as a matter of fact, real disposable income is falling—which means that the consumer, which is 70% of the U.S. economy, is not able to spend.

The jobs numbers have been somewhat stronger, but most of the jobs created recently are low-paying, while the labor participation rate—those aged 16-64 that are actively engaged in the U.S. labor market—remains at 30-year lows. People have given up looking for work!

Add to this the fact that gas prices remain stubbornly high and U.S. manufacturing is still weak, and this makes it harder to build a case for the S&P 500 to continue its climb higher.

As if the U.S. didn’t have enough to handle with its own economic problems, Europe is in a recession and China—along with many parts of Asia—is slowing down as well. That slowdown has been accelerating in 2012, which will provide another hurdle for the S&P 500 and this stock market rally to jump in order to reach record highs.

This is a classic bear trap, where the stock market and the S&P 500 appreciate, while the economic fundamentals continue to deteriorate. As history has shown, eventually, the S&P 500 and the stock market always reflect the economic fundamentals.

The strong stock market rally of this year feels like the calm before the storm, which is what I believe it is.

I continue to believe that the stock market rally, which began in March of 2009, has fed on the U.S. government taking on too much debt, an artificial, prolonged period of interest rates at record lows, and money printing by the Federal Reserve. (See: The Land Debt Built). A true stock market rebound is built upon strong economic growth, where the economy increases the wealth of everyone involved…the opposite of what is happening today.

Beware the bear market trap, dear reader; it is playing itself out exactly as I predicted it would.

Michael’s Personal Notes:

There are several key indicators that are questioning the record quarterly rise in the S&P 500, but one sticks out today.

Corporate insiders are officers, directors and the largest shareholders of public corporations. It is critical to follow whether insiders are buying or selling their company’s stock; it could be an indication that they expect to see their company’s stock rise or fall in price.

When corporate insiders are buying large amounts of stock as a group, investors usually think it is time to buy. Conversely, when insiders are big seller, it could mean something is up and so investors might consider selling.

Trim Tabs Research has seen its key indicator, the sell-to-buy insider ratio, go from 5-to-1 in January ($5.00 dollars’ worth of insider selling for every $1.00 dollar of insider buying) to 15-to-1 in February, continuing to 20.8-to-1 in March!

This is the most bearish insiders have been since early in 2011, according to this key indicator. In March of 2012, corporate insiders sold $4.7 billion worth of stock.

This increase in insider selling was confirmed by a key indicator created by Argus Research, which agrees that this level of insider selling has not been seen since February of 2011.

This represents two consecutive months now where insider selling—a key indicator—has accelerated and reached more significant levels. This is certainly a warning sign from a key indicator that investors should heed.

Another key indicator can be found in the forecasts of the companies in the S&P 500 themselves. Of those companies that still provide forecasts, 61% of them have lowered their profit forecasts for the first quarter of 2012, 31% have lifted their forecasts for the same period, and eight percent have kept their profit forecasts the same for the first quarter of 2012 (source: Bloomberg).

As I’ve been talking about in these pages, profit margins for corporations have stopped climbing—a key indicator. In 2011, on the back of productivity and layoffs, corporations were able to improve their profit margins.

Now that corporations have improved and cut where they can, the only way to improve profits is by increasing sales. Again, with Europe in a recession, China slowing down and the U.S. economic recovery remaining weak, sales are going to be harder to come by.

Speaking of profit margins, the last of the key indicators I wanted to address today is that of rising commodity prices. Within the S&P 500 is another index that measures the performance of 24 more common commodities—a key indicator. This total return index includes energy, industrial metals like copper, agricultural products like corn, livestock like cattle, and precious metals like gold bullion.

This S&P 500 commodity index—a key indicator—gained 5.9% just in the first quarter of 2012 and is up 14% over 12 months, with energy, agriculture and livestock being the main drivers of that move upwards.

This general rise in commodity prices will continue to put pressure on corporate profit margins, as 2012 continues to roll along.

The S&P 500 has had an incredible 12% move in the first quarter of this year. However, the key indicators of increased insider selling, more corporate profit warnings and higher commodity prices are strongly questioning how this move can be sustained in 2012. (Also see: U.S. Durable Goods Orders an Ominous Sign.)

Where the Market Stands; Where it’s Headed:

There isn’t much more that I haven’t already said above: corporate insiders are big sellers of stocks, corporate profits are cooling, inflation could push up interest rates, and the economies of Europe and China are in trouble. The bear market rally in stocks that started in March of 2009 is getting closer and closer to the end of its rope.

What He Said:

“Even the most novice investor can now read the chart of the Dow Jones U.S. Home Construction Index and see that it is trading at its lowest level in five years. If, like me, you believe that stocks are an indication of what lies ahead, this important index is telling us that housing prices are headed to 2002 levels! What would that do to the economy? Such an event would devastate the U.S. ” Michael Lombardi in PROFIT CONFIDENTIAL, December 4, 2007. That devastation started happening the first quarter of 2008.