Insights & Advice

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The market’s window is getting smaller

This week the benchmark S&P 500 Index made a minor new high for the year. While that is cause to celebrate, the question to ask is how much further can we climb in the face of a slowing economy before suffering a meaningful pullback?

During the last few months, investors have been warned by just about every economist worth their salt that the country needs another jolt of federal stimulus. This has not happened. You can cast blame on whomever you want for that failure, but none of that matters to the more than one million American workers who lost their jobs in the past week.

Even the Federal Reserve Bank, in releasing its July 28-29 Federal Open Market Committee meeting notes, expressed concern over the future of the economy. The members warned investors that the coronavirus would likely continue to stunt growth and potentially pose dangers to the financial system. They too have been urging the government to add more fiscal stimulus to the equation.

The longer it takes for Congress to respond to this urgent need, the smaller the window becomes for the market’s continued advance. Right now, most observers do not expect even a “skinny” stimulus deal to be passed before September at the earliest.

When thinking back to the Financial Crisis of more than a decade ago, I recall it took a fairly substantial decline in the averages to convince the politicians to take action. Could that happen again? Unfortunately, some of the conditions for just such a response are present.

As I mentioned, investors have regained all their market losses and are now basically even for the year. At the same time, valuations are stretched, given the present recessionary state of the economy. Investors have paid scant attention to fundamentals during the pandemic. Companies have been given a pass even though they have been reporting horrendous sales and earnings results, but at some point, they may matter again.

It was more than interesting that the markets and gold sold off on Wednesday after the FOMC notes were released. Remember, the financier markets have been wholly dependent on the Fed to bail them out ever since the March 2020 bottom. Therefore, when the Fed publicly states that they are worried about the future, markets pay attention.

If we look at the most recent U.S. Advisors Sentiment for this week, we find that bullish sentiment (usually a contrary indicator) is at its highest level (59.2%) since mid-January of 2020.  What’s more, the spread between bulls and bears is at 42.7%. That number exceeds the spread in mid-January. Numbers like that are a warning sign to prepare for some kind of downdraft in the stock market.  It may not occur this week, or next, but usually one can expect a sell-off within a month or so. And while these are different times and circumstances, I think readers would do well to pay attention to indicators like this.

By the way, my apologies for last week’s column. I had expected a trade meeting between Chinese and U.S. officials last weekend, but it was postponed shortly after my column was published. Evidently, the meeting is now back on track, although no date has been set for the virtual review of the Phase One trade deal. However, if anything, the tension between the two parties have increased since then, so I will be paying close attention to the outcome of that meeting.

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