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What Happens If the Stock Market Doesn't Correct Soon?


The current cycle could stretch into year-end, where the markets might stumble as they contemplate another government shutdown.

A permabull is defined as somebody who is always upbeat about the future direction of the stock market and the economy. Recently I have been called a permabull by certain members of the media, which may be true since March of 2009, but certainly not true over the past 14 years. Recall, in September 1999 I wrote about the Dow Theory "sell signal" that had occurred. Then there was the Dow Theory "buy signal" of June 2003. Most important was the Dow Theory "sell signal" that was registered on November 23, 2007. Obviously, I am not a permabull. As my father used to tell me, "If you think the markets are going up, be bullish. If you think they are going down, be bearish. And, if you think the markets are going to go sideways, be boorish."

Even over the past four and a half years there have been occasions where I have suggested raising some cash when I thought a meaningful decline was coming. That strategy worked in 2010, 2011, and 2012, but this year I was adamant that "sell in May and go away" was not going to play. However, I did wrong-footedly target mid-July through mid-August for a meaningful decline to begin, but corrected that "call" when Vladimir Putin pulled our president out of his Syrian crisis. Yet my mantra ever since March 2009 has been, "You can be cautious, but don't get bearish." So in response to the "permabull" label, this morning I am going to discuss some of the bearish divergences that have been developing in US markets recently.

First is the divergence between the Russell 2000 (INDEXRUSSELL:RUT), which serves as a benchmark for small-cap US stocks and which has been noticeably weaker than the S&P 500 (INDEXSP:.INX). Since the RUT has been stronger than the overall stock market all year, its recent weakness could potentially be a downside "tell."

Next is the attendant series of charts showing the divergences between the SPX and a rise in interest rates in the high yield complex, the decline in third and fourth quarter GDP estimates, the collapse of forward earnings estimates for the S&P 500, and most troubling, the collapse in Bloomberg's Economic Conditions Index. Studying that chart, one observes how tight the correlation between Bloomberg's index and the S&P 500 has been over the past four years, until recently. In fact, in decades of monitoring the Bloomberg Economic Conditions Index, I can't recall such a divergence ever occurring. The implication is that business conditions are slowing at a very rapid pace, but the equity markets are ignoring that. Of course it could be as I have suggested in that nobody is going to pay any attention to the economic data until December because of the shutdown and the debt ceiling debate.

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No positions in stocks mentioned.
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