Market Crosscurrents

Recently, several well regarded skeptical-to-bearish market mavens (Jeremy Grantham, Barry Ritholtz, and Dennis Gartman) have independently come to the same point of view, namely that the stock market has become disconnected from reality and is trading on momentum, and the trend will accelerate. A quote from Ritholtz’s post “Buying Panic” was widely cited:

In a seeming paradox, we have a rapidly accelerating market, and a rapidly decelerating economy. Hopes for a rate cut in the face of this asset inflation are pushed out further and further into the future. This is now a trading market, where momentum and trend dominate, increasingly detached from the decaying domestic fundamentals. Global growth remains strong, and despite that – or perhaps because of it – US markets are lagging their overseas peers.

How much further this market can rally is anyone’s guess, but a “Melt-Up” to Dow 14,000 would not surprise us.

Stephen Roach, chief economist at Morgan Stanley (and another bearish sort) threw cold water on the idea that the US economy and the rest of the world would stay decoupled for much longer in a Financial Times comment:

The debate over the global outlook is actually very simple. The key question is whether the current US slowdown has broader cross-border consequences. For financial markets, which are still discounting relatively sanguine world growth prospects for 2007-08, there is great enthusiasm for a global decoupling – that rosy scenario whereby the rest of the world miraculously untethers itself from the US. My advice is to keep the champagne on ice….

So far, however, the US slowdown has been concentrated in the least globalised piece of the US economy – homebuilding activity….While the housing recession has reduced US demand for some foreign-sourced construction materials, the rest of the world has hardly shivered as the McMansion assembly line has slowed. So far, the steep contraction in residential construction activity has not had a big impact on the remainder of the US economy. That is especially the case for personal consumption – more than 70 per cent of US GDP and, by far, the most global sector of the US economy….

As long as the US slowdown is confined to housing and the consumer remains unscathed, there is a limited likelihood of a more broad weakening in the global economy. But if the consumer goes, so too will those economies that rely heavily on export growth to the US….

In the end, this debate boils down to the one big call that has always weighed most heavily on the macro outlook – the fate of the American consumer. With property wealth effects now turning negative in a post-housing bubble climate, I suspect the income-short, overly indebted American consumer will struggle to remain resilient….

If I am wrong and US consumption growth remains brisk, then a globalised world will, in effect, have nothing to decouple from.

If it doesn’t, don’t kid yourself: if the lead engine of the global growth train goes off the tracks, the rest of the world will be quick to follow and the hopes and dreams of global decoupling will be in tatters.

So even the latest optimistic theory about the market appears dubious. And we have a perverse confirmation of the explosive rally thesis from an unexpected source. Uberbear Richard Russell has gone wildly bullish (and the cliche is that when the last bear loses faith, the markets are about to turn, which would seem to confirm the earlier trio’s view that the hyperbolic up-phase will end in tears). We found this MarketWatch story that quotes Russell’s newsletter thanks to Michael Shedlock:

We saw something that is extremely rare [on April 20 and April 25], in fact I can’t remember ever having seen this before. What I’m referring to is that on those two dates all three Dow Jones Averages — Industrials , Transports, and Utilities — closed at simultaneous historic highs. To me, a fellow steeped in Dow Theory for over half a century, this was like a clap of thunder… My take on the situation is that the stock market (and the Dow Theory) told us that an unprecedented world boom lies ahead.

Now just to keep things interesting, there are always contraindicators. A sensible post by Larry MacDonald on Seeking Alpha gives some negative near term indicators for the market (note one he cites, the VIX rising, was one warning sign of the February 27 ratchet down, but in that case, the VIX has spiked up rather than crept up):

Is it time to buy put options on the market indexes or inverse exchange traded funds? Maybe so: with stocks having gone on a tear and now looking overbought, perhaps it’s time for some portfolio insurance. A choppy patch could be in store, a correction that gives this bull market time to rest.

Some of the signs of overheating:

• a CNNMoney.com article notes that 24 of the past 27 days have been up for S&P 500 index, tying a record not seen since 1927.

• insiders are unloading into the rally (as noted in an earlier post)

• the VIX measure of volatility is not going down – it is edging up

• the spread between corporate and government bonds is edging up.