Pullback of Stock Market
Sell-Off Imminent!

Negative Market Conditions Creates A Pullback!

15 Reasons To Sell Now!

by Ian Harvey

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April 04, 2013

Introduction

Whilst many investors, economists and analysts are bullish for the Standard & Poor's 500 Index (SPX) for the long term, they see too many negative market factors in the current run that appear to be setting up for a pullback.

In early 2010, 2011, and 2012, run-ups in the stock market, similar to this year, pushed stocks up about 10% for the year as April began. Specifically, on April 23, 2010, April 29, 2011, and April 2, 2012, the S&P 500 made peaks that were followed by 10–19% losses that were not recouped for more than five months. This recurring phenomenon is often referred to by the old adage “sell in May and go away.”

Several factors and indicators suggest a correction may not be far off, even while the new high provides a big psychological boost to an already confident market.

Factors That May Cause or Signal A Pullback!

1. Standing Alone Rally

The isolated bullishness of the U.S. market in a global marketplace is a concern. Even though U.S. indexes are up about 10% year to date, emerging-market stock indexes — those in Brazil, Russia, India, and China — are far from rallying. Brazil’s Bovespa is down about 8% for the year, while China’s Shanghai Composite is down just over 1% for the year, with the others falling in between. Europe is faring slightly better with the Stoxx Europe 600 index up 5% for the year.

The question remains -- can the U.S. rally without the rest of the world?


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2. Economic Surprises

The Citigroup Economic Surprise Index, measures how economic data fares compared with economists’ expectations and has marked the spring peaks in both economic and market momentum in recent years. While the latest readings have not surged up near the 50-level that marked the peaks of recent years, the weakening trend does suggest expectations may have become too high. Turning points typically have coincided with a falling stock market relative to the safe haven of 10-year Treasuries.

3. Initial Jobless Claims

It was evident that first-time filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. In 2012, April again led to deterioration in initial jobless claims as they jumped by about 30,000. While claims have fallen to post-recession lows this year as the labor market has improved, we will again be watching for a move higher in April that would echo the spike seen in recent years.

4. The Sequester

Expects layoffs related to U.S. federal budget cuts known as the "sequester." The job cuts will likely "crush the market."


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5. European Stresses

One issue important to the markets, is the surge in European stresses—evident in the spring of each of the past few years. The weakening economic data in Europe’s core countries such as Germany and France (seen most recently in last week’s German manufacturing and sentiment data), combined with financial stresses in peripheral countries such as Cyprus pose a risk to global markets if too little is done to address the key issues. Europe continues to focus on capping banker bonuses and financial transactions taxes rather than core issues. This could risk a bond market sell-off that could negatively affect stocks here in the United States, similar to the spring pullbacks in recent years.

Slovenia is likely to be the next euro zone country to seek an international bailout, given the fragile state of its banking sector. Following the Cyprus bailout, Slovenia's dollar bonds have dropped by nine points over the past two weeks as investors worry about the Balkan country's troubled banking sector and the government's ability to tap the international capital markets.

6. U.S. Dollar

Another concerning factor is a stronger U.S. dollar against a weaker euro, investors continuing to pile into bonds even with low yields, and the lack of a so-called “Great Rotation: with money not coming out of the bond market.

7. Fed Stimulus

In 2010 and 2011, Federal Reserve (Fed) stimulus programs known as QE1 & QE2 came to an end in the spring or summer, and stocks began to pullback until the next program was announced. Operation Twist was announced on September 12, 2011 and was scheduled to conclude at the end of June 2012, helping to prompt a market slide before it was extended at the end of June 2012. This year, the current program is unlikely to be slowed or stopped until much later this year. Therefore, this is unlikely to be a driver of a slide in stocks this spring.

8. Consumer Confidence

In the past few years, early in the year the daily tracking of consumer confidence measured by Rasmussen rose to highs just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a sell-off as buying faded. Investor net purchases of domestic equity mutual funds began to plunge and turned sharply negative in the following months. This measure of confidence is once again beginning to pullback from the highs.

9. Yield Curve

In general, the greater the difference between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy. This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of 2010 and 2011, and March of 2012. Then the curve started to flatten, suggesting a gradually increasing concern about the economy, as the yield on the 10-year moved down. Although not as steep as in prior years, this year may see the yield curve flattens further after peaking in mid-March.

10. Earnings Revisions

The earnings estimates moved higher heading into the first quarter earnings season of each of the past few years, only to begin a pullback that lasted the remainder of the year as guidance disappointed analysts and investors. This year, earnings expectations have not risen as much as in prior years, which may limit the disappointment. In addition, we saw disappointing reports from bellwethers such as Oracle and FedEx, among others. It is too early to say whether this indicator is flashing a warning sign.

11. Energy Prices

In 2010, 2011, and 2012, oil prices rose about $15–$20 from around the start of February, two months before the stock market began to pullback. This year, oil prices rose to $98 at the start of February and have eased slightly since then, suggesting less risk to consumers already struggling with higher taxes. However, the national average retail gasoline price has risen 50 cents this year, similar to the average rise from the beginning of the year through March over the past three years. With prices starting to ease along with crude oil the risk is fading, but a further surge in prices at the pump would make this indicator more worrisome.

12. The VIX

In each of the past three years the CBOE Market Volatility Index (VIX) ), an options-based measure of the forecast for volatility in the stock market, fell to the low of the year in the low-to-mid teens in April before ultimately spiking up over the summer. In recent weeks, the VIX has declined once again to the lows of the year. This suggests investors have again become complacent and risk being surprised by a negative event or data which may bring on a pullback.

13. Inflation Expectations

The University of Michigan consumer survey reflected a rise in inflation expectations in March or April of the past three years. In fact, in 2011, the one-year inflation outlook rose to 4.6% in both March and April from 3% at the start of the year. This year, there has been almost no rise in inflation expectations, as they remain about 3.3%.


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14. Seasonality Causing a Pullback!

The S&P 500, along with the other major indexes, may be tripped just by simple seasonality. While there have been exceptions to the rule, the best six-month period for stocks tends to be November to April, and we’re about to transition to the worst part of the cycle soon with stocks at all-time highs.

15. "Sell in May and Go Away”

Investors may sell en masse to get ahead of those who practice the market dictum "sell in May and go away," where investors lighten up positions ahead of the summer holiday, causing a pullback of the market.

Conclusion

For the most part, retail investors, many of whom have sat on the sidelines, are still wary of the rally, that it could be a classic bear trap, where heavily invested institutional investors start profit taking once the retail investor buys in at record highs. Even with that reluctance, flows into stock funds have been positive for 11 weeks straight, their longest streak since 2010.

On balance the factors and indicators do not point to a significant risk of a repeat of the 10–19% spring slides in the stock market this year. However, a smaller pullback of about 5% or so is far from out of the question and remains the most likely scenario.


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