Correction, or resumption of a major downtrend? (page 1 of 2)

According to the Yale School of Management's opinion poll, currently 95% of individuals and close to 92% of financial institutions believe that the US stock market will rise over the next 12 months.

The bull to bear ratio has recently also reached extremely high levels, which are usually associated with major tops, while low readings such as we had in October 2002 occur near market lows

Incidentally, I encounter the same type of optimism everywhere around the world. The consensus believes that a small correction will unfold in the near term but that thereafter equity markets will resume their strong up-trend.

Always being skeptical of the consensus, I am afraid that the equity markets may be forming a more significant top between now and April, which may not easily be exceeded for quite some time.

First of all, more than 90% of all stocks listed on the NYSE are trading above their 200 days moving average, which usually is indicative of a market that is very overbought. Then, the Dow Jones Industrial Average at 10,500 is encountering significant overhead supply, which comes from the Dow's trading range of between 10,500 and 11,500 from the middle of 1999 to the middle of 2001.

Also, as I have pointed out before, stocks tend to reach bargain levels amid very negative news, whereas tops coincide with very high bullish sentiment and favorable economic news. Then, it is of some concern that despite all the "good economic news" that the government publishes, the economically extremely sensitive airline shares have recently taken a beating and that the Dow Jones Transportation Average has broken down.

Particularly hard hit were the no-frills airlines such as Jetblue Airways (down 70% from its October 2003 high) and Ryanair (down almost 50% since mid-January of this year). Add to the weakness of airlines the recent decline of the economically equally sensitive semiconductor stocks, which are now (including Intel) no higher than they were in October 2003 and one begins to wonder whether the market isn't beginning to discount some renewed weakness in the economy later this year.

Another possibility is that the stock market doesn't entirely trust the glowing economic statistics published by the government, which don't seem to tally with the economic reality of most households, as discussed above.

In this respect, the recent strength in bond prices is interesting. Seemingly, the bond market isn't entirely convinced by the "strong economy" statements by the US policy makers nor by the published glowing economic statistics. Still, what might unsettle the bond market is US dollar strength and rising inflation rates due to soaring energy prices.

Moreover, our readers should consider whether BBB corporate bond spreads over treasuries have collapsed because of a significant improvement in the quality of corporate debt or whether they have collapsed because of a significant deterioration in the quality of US government bonds. Could, as is frequently the case in the emerging markets, corporate debt have a lower yield than US government debt?

With respect to the strength in the bond market, I suspect that declining interest rates are an indication that the consumer has very little spending power left. Employment gains are minimal and real incomes are declining as prices are rising far more than what the government's statistician are publishing.

In this regards it is interesting to look at a recently article published by the Vancouver Sun in which the author, Chad Skelton, compares some prices of goods and services between 2002 and 2003.