The Fed announced that 10 out of the 19 banks failed the bank stress test and need to raise a combined $74 billion. As expected, Geithner said no bank was in danger of insolvency. Everything is rosy, nothing to worry about. Banks are just fine. No surprise here!
Meanwhile…
Yesterday, I pointed out that both the daily and the weekly stochastics were extremely extended in the 90%+ range. Short cycles turned negative today, especially in the Nasdaq Composite and the Nasdaq 100. This is a warning shot.
Here is another warning sign of the danger of getting too enamored with the stock market here in May.
Contrarians have long known that when the public gets too bullish or too bearish, watch out for traps.
As you can see from this Stockcharts.com chart, bullish sentiment for the S&P 500 is now near 74%.
When the majority of investors line up on one side, watch out. As you can see, these sentiment readings are not linear, they’re cyclical and when they get out on the limb this high, predators go in for the kill.
Let’s me point out a couple of other issues on my radar screen.
I don’t know if you have been looking at government long-term bonds but they have been falling like a rock. All of this spin by the Fed of a recovery in the next few months has been motivating investors to sell their positions in government bonds.
In February, the long bond essentially offered nearly a zero return but carried a huge amount of downside market risk. The Fed promised to support the long bond in its “Quantitative Easing”.
In truth, they haven’t been able to keep the long bond stable.
This poses a big problem for the Fed because a fall in government bond prices means a rise in yields. A rise in yields means a rise in mortgage rates, which means more and more people will not be able to qualify or refinance their homes.
The Fed has lost control of the long-term yields. The only way for long-term yields to come down is for fear to return to prompt investors out of the stock market and back into bonds.
This means that mortgage rates are now going up, so here again the idea of a housing recovery is an illusion, especially if mortgage rates start climbing again. This isn’t good news for housing prices as it cuts into demand.
The political spin of an immediately recovery has produced another effect and that is rising crude oil prices, which reached a high today of $58.57.
If gasoline prices rise this summer, it demands more out of people’s budgets and also undercuts economic growth in the summer months.
$60 crude oil is way better than $140 oil, but rising oil prices is anti-growth for most companies and undercuts the whole notion of an economic recovery should crude prices climb to $70 or $80 this summer. A $12 or $18 rise in crude oil is not out of reach, especially if the Fed keeps fanning a robust recovery is before us.
From my experience this is one of the biggest reasons why the summer months tend to do poorly – because energy costs tend to rise in the summer.
The key point I want to drive home is that prices move in cycles. Investors anticipate and then adjust. We reach extremes that have to be corrected. When the Fed pushes to hard in one direction, problems crop up in bonds and crude oil that threatens to derail growth, so we get this breathing effect.
The market needs to exhale in extreme market conditions, so look forward and not backward. What has happened has happened. Don’t assume that what has happened will continue without an adjustment. It just doesn’t work that way.
Keep your eye on the 14-day RSI values on the daily charts. A breach below 50% is confirmation that the intermediate-term cycle is rolling down.
Remain defensive.
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