Nothing ever goes exactly according to plan in the capital
markets. I've seen minor divergences, disconnects, and dichotomies from time to
time in the almost two decades I've been in the investment and financial
education business.
But right now? I'm seeing some of the greatest disconnects
EVER! Take earnings versus stock prices. Corporate managements have been warning
about weakness left and right. Overall S&P 500 earnings are poised to drop
as much as 4% this quarter, while revenues are going to drop for the third
straight quarter. That hasn't happened since the Great Recession.
But the Dow Jones Industrial Average has surged almost 1,700
points from its late September low. The PowerShares QQQ Trust (QQQ) just traded
to within a couple bucks of its summer high. Since stock prices are supposed to
track earnings results closely, the divergence makes no sense.
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That brings us to the next major disconnect: Mega-cap stocks
and broad market averages versus several market sectors and small caps.
Sure, the QQQ has been strong and so has the Dow. But the
Russell 2000 has barely bounced. It's still roughly 10% below its June high.
The Dow Jones Transportation Average is also more than 1,100 points off its
highs.
Retail stocks trade like death warmed over, as do
biotechnology names. Energy joined them in the doghouse this week after crude
oil and natural gas plunged.
Can a gain in a handful of big cap stocks hold up the
averages, even as hundreds of stocks behind them wilt? That seems nuts to me,
frankly.
Can a gain in a handful of big cap stocks hold up the
averages, even as hundreds of stocks behind them wilt? That seems nuts to me.
Or how about the disconnect between the performance of
Treasury bonds and stocks? When stocks rise, bonds typically fall, and vice
versa.
But that hasn't happened this time around. Bond prices have
risen and bond yields have fallen despite the rise in stocks. That's a glaring
non-confirmation of the rally.
Then there's the massive disconnect between commodities and
stocks. You would expect to see both asset classes rally sharply if the global
economy was strong, and demand for commodities and the products they go into
was firm. But commodities can't get off the mat despite the rally in stocks.
That brings me to yet another major disconnect — the plunge
in energy prices and the consumer's lack of a response to it. How many times
have we been told that falling gasoline prices would cause retail spending to
skyrocket? How many so-called "experts" came on television and said
American consumers would be dancing in the streets?
But have you been listening to Wal-Mart Stores (WMT)? Have you seen a chart of the SPDR S&P
Retail ETF (XRT)? Did you see how retail sales missed forecasts in September,
and flat-lined in August? Or how consumer confidence fell to 97.6 in October
versus 102.6 a month earlier, despite further declines in gas prices? These and
other data points show the "retail boom" thesis isn't panning out at
all.
But suffice it to say my research suggests these disconnects
are going to be a big problem for investors. I believe they merit a cautious investment
approach -- one that focuses on using hedges to protect against downside risk,
maintaining elevated cash levels, and owning only the "best of the
best" stocks in non-economically
sensitive and higher-yielding sectors of the market. Until next time, Mike
Larson
Money and
Markets
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