What a perfect day to start blogging on the stock market and general economy! The stock market was up over 200 points today on the Dow Jones Industrial Average and nearing multi-year highs at 10,400. From a technical perspective the bullish investors are looking for a continued breakout of stocks, while the bears are praying that the resistance levels at the upper end of 11,000. If not, the markets could rocket up to their highs of 14,000 as there is no real resistance between that level and 12,000. One thing to note, the market only reached above 12,000 for a period of nearly 2 years, crossing above for the first time in October of 2006 and last crossing below that line in June of 2008.
On the S&P 500 a potential double top exists right where the index currently sits around the 1,220 point level. The S&P 500 made a massive double top in years 2000 and 2007 around 1,500 points and potentially if it breaks through the 1,250 point range; 1,500 could be the next legitimate resistance point, (potentially 1,400, though not as strong). This information shows, technically speaking the markets are at a crucial technical crossroads.
Well, you might ask why the downside has not been mentioned. Simple answer: I like to save the best for last. When one decides on an investment, the main focus is too often on the upside, when the primary focus should be risk management. If you have an expected upside of 15% return one might be satisfied, but, what is the risk associated with that potential gain? On the stock markets the potential upside gain is approximately 20% to those aforementioned levels on the Dow and the S&P 500, but the risk, is potentially much more.
The markets have risen nearly straight up (from a longer term view) since March of 2009, a rise that has equaled an over 70% gain from those incredible lows. Now, there is reasonable short term support at 9,500 on the Dow, but not incredibly strong until around 8,000. If the market did fall to this 8,000 level the downside risk would be nearly 30%. Not only is this risk higher in a support to resistance level comparison but this is also after the market has risen 70% in a rather anemic economy.
This is where the fundamental analysis comes in. Mortgage and financial asset problems have been key factors to the economic downturn we are experiencing. Those assets are still very low in value and potentially going lower. The rises we have seen in home prices recently have been regional at best and have not been consistent. Median home prices (a significant source of wealth in America) are nowhere near their highs from 2006-2007 and yet the stock market is trying to push back to those pre-crisis levels. A commentator on Bloomberg today, said how it almost appears the Fed is attempting to push up the stock market with quantitative easing to convince the American people that the economy is recovering and strong. The term dead cat bounce is appropriate here. When an asset falls, there will be demand levels that support the assets; but if supply exceeds each demand level, prices will fall until the demand can support the supply.
This is essentially the cycle the housing market is caught in. The number of foreclosures is at all time highs and growing. The amazing part is that the banks are still withholding large inventories of these foreclosed homes in an attempt to not flood the market and push prices down. The problem lies in the fact that the economy needs to recover for the real estate market to rise, and the real estate market needs to rise for the economy to recover. It is my opinion that the housing prices will continue to fall until true demand is able to support the prices long term. Many speculators have gotten burned in this market and ultimately, long term these speculators will not be able to support the home prices. Long term ownership is generally what stabilizes and grows home prices for the long term. At the current prices, many housing regions, especially California and Florida are still too high for potential long term home owners to buy and as long as this problem exists it will continue to weigh on the economy. (I will devote another blog post to the root of the mortgage woes, that will help explain why the reliance on these home prices).
With these home price woes in mind and the current high unemployment rate (nearly 10%), one must ask, is the economy really recovering? It is something that can really only be answered longer term when using hindsight, but from the indicators I can see the rise in GDP has been a function of the incredible fall in GDP not in a recovery of the economy. The more I analyze the economy, the more it resembles the 1930's American economy of the Great Depression (more on this as well in further posts). If this is even partially the case, it would be wise to evaluate if the market is worth investing in at this current time.
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