Saturday, July 18, 2015

Is This A Bear Market Rally?

Netflix CEO Reed Hastings shocked by 16% stock jump!
Some of the rather bizarre market action recently has me wondering if we are in the middle of a bear market rally, and if so how violently it might end. Several stocks on an uptrend appear fundamentally unstable and lack a certain and important "je ne se qua" such as earnings and profit. The french phrase je ne sais quoi as you know denotes a elusive quality or attribute that is difficult to describe or express. It literally means "I do not know what". It is often used when referring to that special intangible quality that makes something or someone distinctive or attractive, in the case of stocks I find profitability as "something" rather important.

Lately in an effort to justify high stock evaluations we have seen profitability being discounted and taking a backseat to things like market momentum. I consider this a dangerous situation. When stocks like Amazon that are trading at an astronomical P/E then miss earnings, or actually lose money, it is hard to explain why stocks prices reverse after a sharp drop then close the next day posting huge gains. Recently, we have witnessed massive moves in several speculative stocks like Tesla and Netflix that are hard to defend by any other reasoning than shorts being squeezed out of the market. May I suggest the market has become so distorted it no longer reflects reality and that those with short positions rushing to the exits are responsible for most of the price action now taking place. 

An unholy alliance made up of the Federal Reserve, the government, and the too big to fail has placed the markets in a rather precarious place. For the big boys, it's insider information and computer trading, this includes using computer programs that exploit where stops are placed that improves their ability to wash the weak out of their positions. With many investors skeptical of the ever upward moving market we are increasingly seeing bears putting a toe into the water and establishing short-positions with tight stops. It seems many of these bears are very timid and these stops rapidly come back to haunt them, it is as if they have painted a target on their back. When they exit and buy back their positions we find they have done the heavy lifting for those wishing to manipulate the market ever higher.

All this action has elevated the "buy the dip" and "don't fight the Fed" mantras to new levels. Following the 2008 collapse the market started showing some odd patterns and many of us saw these as the result of what we called the "plunge protection team" this team appears to have  morphed into a full fledged market manipulation vehicle over the years. Time and time again we has seen the type of reversal Goldman Sachs and JP Morgan backed by the Federal Reserve can generate with a concerted effort to buy S&P 500 index futures at crucial support points late in the day. They have proven it is more than enough to turn the markets from red to green in the blink of an eye. In many cases light volume makes these moves even more suspicious.

While those holding long positions have been busy patting themselves on the back and taken to bragging about their cunning ability to pick stocks the market has moved to where it does not reflect reality. We must and should on occasion look at the underlining assets supporting these valuations. The bottom-line is that the higher the market goes the more vulnerable it becomes to a major collapse and sudden downward move. A lack of short positions will bode poorly for the market if it falls rapidly because in such a situation as shorts take profit and buy back their positions they act as a floor under the market giving it support. In this distorted market we may find the floor is very weak or only an illusion.

Linking this all together and the main justification for such market manipulation is the idea that higher equity prices will reflect a strengthening economy and create a wealth affect that will drive more consumer spending. Like many investors I feel the growing gap between what is happening on Main Street and stock evaluations is a harbinger of problems ahead. A bit of deja vu is in the air, we have seen this all before. Way back in 2007 we saw all stocks moving in unison, always upward, often ignoring both the news and reality, it is happening again. This is a reason for caution! If it looks like a Ponzi scheme, sounds like a Ponzi scheme, and feels like a Ponzi scheme, then it is probably a Ponzi scheme, and as history has shown these schemes do not end well.

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