5 Reasons Bears Say Stocks Could Dive 60% From Here
The stock market rallied Thursday, reestablishing a confirmed uptrend, as the government reported strong retail sales and employment data.
The technicals show the market is in a solid uptrend but the bears contend an overwhelming amount of evidence suggests the bulls are headed to the slaughterhouse.
PowerShares QQQ ( QQQ ), tracking the 100 largest non-financial stocks on the Nasdaq, jumped 1.27% to 72.76 in below average volume.
SPDR Dow Jones Industrial Average ( DIA ) picked up 1.27% to 151.76 with trading lighter than average.
All three major indexes found support at their 50-day moving averages, which is very bullish. Investor's Business Daily changed its market outlook to a confirmed uptrend because of the S&P 500's strong action.
"The upward trend is still intact," said Anthony Welch, president of Sarasota Capital Strategies in Osprey, Fla. We've seen that level be solid support all year, so for now, it just looks like another common pullback.
The market will likely chop around between support at its 50-day moving average and resistance at its new high for several weeks as many stocks have to work off overbought conditions, says Mark Arbeter, chief technical analyst at S&P Capital IQ.
"Once this ends, we see new all-time highs for the market," Arbeter wrote in his weekly technical report. "So far, the market has not traced out a major top. Despite the negative intraday price action during many days since the May 21 closing high, there have been signs that the bulls continue to step in during the recent decline as they continue to buy the dips."
The Bear View
The bears on the other hand believe the market is due for a deeper correction after rising 15% this year and 23% in 12 months. Some contend the economic fundamentals suggest the market should crash below its 2009 low, which would amount to a nearly 60% drop from Thursday's level. Here's five reasons why:
1. From a contrarian point of view, investors are too bullish.
Breadth indicators that Tom McClellan, founder of "The McClellan Market Report," tracks shows "big negative readings." And from a contrarian perspective, bullish sentiment still heavily outweighs bearish sentiment in the Investors Intelligence survey. The difference between the bulls and bears hasn't reached extremes seen at market bottoms, suggesting there's more room for the market to correct, McClellan wrote in his newsletter Wednesday evening.
2. Japan's stock market, which has led the U.S. this year, looks very weak.
The action in the Japanese stock market this month doesn't bode well for U.S. markets as the two have been trading in tandem this year, says Jeff Pierce, founder of Zentrader.ca .
3. Earnings growth has been driven by share buybacks -- not sales growth.
The uptrend this year has surprised Andrew Norman, an analyst with Bull & Bear Mash because corporate sales have been flat and the earnings per share are growing mainly because companies are buying back their own stock, thereby reducing the number of shares that profits are divided among.
"No one can be certain about downside potential, but the economy is in far worse shape than in 2007," Norman said in an email. He expects the market to eventually under cut its 2009 lows.
4. Stocks have surpassed their 2007 zenith but many economic indicators remain deep below pre-recession levels.
This includes nonfarm employment, consumer confidence, total retail sales, durable goods orders, and the Index of Leading Economic Indicators. All the while banking reserves have rocketed into the stratosphere.
The market seemed to cheer the 0.6% growth in May retail sales Thursday. Sales grew 4.3% from the year-ago period. The number is "statistically insignificant" because it hasn't been adjusted for inflation, contends John Williams, founder of Shadow Government Statistics .
"Without real growth in income, and without the ability or willingness to take on meaningful new debt, the consumer simply cannot sustain real growth in retail sales, let alone in the broader personal consumption measure in GDP (gross domestic product)," Williams wrote in a client note Thursday. "Neither confidence nor sentiment has recovered from the post-2007 decline in economic activity, and both measures remain at levels consistent with ongoing, deep recessions."
5. Bonds, which usually trade opposite stocks, are oversold and due for a bounce.
The Commitment of Traders report or COT shows commercial traders -- the so-called smart money -- are heavily buying long T-Note futures while the small traders -- the so-called dumb money -- are heavily shorting T-Note futures in hopes of profiting from falling prices. That suggests bond prices ought to rally as the commercial traders are usually right and the small traders are usually wrong, says McClellan of "The McClellan Market Report."
Bonds have sold off to extreme levels recently because of "confusing communications" from central banks in the U.S., Japan and Europe, says David Kotok, chairman of Cumberland Advisors in Sarasota, Fla. Economic indicators show weak growth and fears of deflation in many countries around the world, which doesn't don't justify higher bond yields.
"If markets have overreacted and bonds are very cheap due to poor communication policies of central banks, then that presents a buying opportunity in tax-free bonds, and we will take advantage of it at Cumberland," Kotok wrote in a client note Wednesday.
Investors withdrew $7.7 billion from U.S. mutual funds and exchange-traded funds for the week ended June 13, Lipper Inc reported Thursday. A vast majority of the total outflows -- $5.5 billion -- came from taxable bond mutual funds and ETFs .
iShares MSCI EAFE Index (EFA), tracking developed foreign markets, popped 1.53% to 60.46. EFA has tumbled below its 50-day line but still trades above its 200-day moving average, which indicates a weak uptrend.
iShares MSCI Emerging Markets Index ( EEM ) surged 2.12% to 39.11 after touching a nine-month low the prior session. The laggard among global markets trades deep below both its 50- and 200-day moving averages, indicating a very strong downtrend.
Follow Trang Ho on Twitter @TrangHoETFs .