Thursday, April 26, 2007

The "No Bad News" Market April

In honor of the Dow Jones Industrial Average crossing 13,000, we look at a market fully disconnected from its exposure to risk.

What characterizes this disconnect? There can literally be no bad news. For example:

Consumer spending drops. Excellent! The Fed will have to lower rates.
Consumer spending rises. Wonderful! Corporate profits will continue rising, too.

Fewer jobs were created last month. Outstanding! Weakening job market will push Fed to lower rates.
More jobs were created last month. Super! Rising employment will drive higher spending and profits.

Inflation drops. Wow! Corporate profits will rise as borrowing costs decline.
Inflation picks up. No worries. The "core" rate (i.e. everything which increases in price has been subtracted) is still basically zero. Party on!

Housing starts rise. I'm lovin' it! The "softness" is done, housing is strengthening, the boom continues.
Housing starts fall. Great! With fewer houses being added to inventory, then the inventory will get worked off quickly, setting the stage for--you guessd it, another boom!

This could easily be extended to cover any news whatsoever:

Los Angeles leveled by giant quake. Construction boom will drive commodities and sales ever higher--this will be a fantastic boost to employment.

Saudi Arabian government overthrown, radical Clerics in charge. The doubling of oil to $150/barrel will drive energy company profits and boost spending on alternatives--profits will abound.

China's economy falls off cliff, social unrest widespread. This will reduce that pesky trade deficit and cut oil demand in China, lowering prices for U.S. consumers. T

his could be a board game: the "no bad news" stock market. You draw a "disaster card" and then have to spin it into good news which boosts "market prospects."

But before we start believing the game is actually real life, let's look at some charts: Note how the DJIA swings from the top to the bottom of its channel. It has punched through the upper band decisively, suggesting a reversal is in order.

Note how the VIX has retraced, setting up a potential "third spike" eerily similar to what unfolded last July. As for market sentiment--there is only one word to describe it: euphoria. There can never be any bad news, so it can only run up. The only danger is being out of the market.

Does this strike you as an extreme of bullish sentiment? As a market disconnected from an economy in which foreclosures are rising by double-digits every month? Join the party if you must, but keep an eye on the punchbowl--it's looking like it was spiked with a vintage March 2000 elixir that packs a real hangover.

One last note: Technical Analyst Rick Ackerman over at Rick's Picks has long identified 13,045 as an important top in the DJIA, and now that the DJIA has blown past that to close at 13,088, he has raised his target a couple notches. Various bullish pundits are already touting Dow 14,000, saying it's only 7% higher; the fact that a thousand points is now considered a modest step suggests to me that the bullish fever is about to break.

To see charts, please visit

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