Stock Market Pullback: Waiting for the Other Shoe to Drop

When it comes to the stock market in 2012, given issues with unemployment in the US, debt problems in Europe, and tension in the Middle East, it is as if we find ourselves waiting for the other shoe to drop.

MarketWatch's Carla Mozee reported Saturday that "investors may find a reason to book gains next week if labor-market figures prove a disappointment." According to the article, "jobs will dominate" the action on Wall Street the week of March 5. The US Labor Department's February unemployment report will arrive on Friday. Mozee: "'[W]hisper numbers' that suggest a poor report is in the pipline, soft figures from weekly jobless claims or discouraging data from ADP's report on private-sector hiring could trigger a pullback in equities." It is significant to note that Gallup reported on Feb. 17, 2012 that the US unemployment rate increased to 9 percent in mid-February while underemployment is up to 19 percent.

With recent gains in the stock market as the S&P 500 is now up near 9 percent since the beginning of 2012, Mozee's analysis portends a pullback; "people are going to take profits." Even aside from labor market concerns, Mozee noted that "[c]onsumer spending remains a concern for Wall Street, particularly as retail gasoline prices have climbed each day for more than 30 past days." As consumers get squeezed by rising prices at gas stations and grocery stores, we may be on the "precipice of changing consumer spending habits". As such, "weaker consumer confidence and spending 'could derail this market.'" High gas prices and rising grocery bills could make for another long, hot summer in the US.

MarketWatch's Howard Gold has gone so far as to say that gas prices are going to make for a "long, hot spring". Gold: "Continued high gasoline prices could but the kibosh on the economic recovery, which has been picking up steam in recent months. Whereas gas prices are related to consumer spending habits and the flow of business, Gold suggested that gas prices "could be a dark cloud over the economy in the months ahead." Gold concluded that when it comes to the stock market, "bulls seem to have blithely ignored the gathering storm."

In an article for TheStreet.com, Doug Kass recently suggested that economic headwinds could bring a pullback in the stock market. Kass: "My 'fair market value' calculation for the S&P is around 1345 -- so we are now in the overshoot area... Besides the aforementioned secular headwinds [of fiscal imbalances and economic, political, and geopolitical problems], there remain ample near-term economic issues, both here and abroad, that go beyond a developing recession in Europe." With respect to the US economy, Kass discussed that both personal income and spending fell short of estimates. Kass: "As a result of 0.2% personal consumption inflation (Bernanke's favorite measure of inflation), real income was up by only 0.1% and actually dropped by 0.1% as measured by after-tax disposable income. Meanwhile, real spending was flat." Further, Kass noted that drops in the Institute for Supply Management reading and January construction spending were disappointing. With respect to the Chinese economy, Kass commented, "It remains unclear whether China's landing will be 'soft' or 'hard'."

For those who have been following the stock market recently, the prospect for a market pullback should come as no surprise. On Feb. 26, 2012, I discussed how factors related to unemployment and gas prices "seem to suggest that a market pullback is coming." With all the fear regarding gas prices and societal malaise surrounding the labor market, one might wonder why the stock market has rebounded as it has thus far in 2012. Regarding a rise in equities, in the quarterly GMO LLC newsletter, Jeremy Grantham wrote, "Yes, there is more than our normal fair share of potential negatives lurking around, but on our data: a) most of the negatives are reflected in stock prices; and b) all fixed income duration is dangerously overpriced. This last situation is, of course, engineered by the Fed, which hopes to drive us all into taking more risk, notably by buying more equities. I hate to oblige, but at current equity prices it just makes sense to do what they want... Equities are also good long-term hedges against inflation."

Speaking of long-term hedges against inflation, gold is currently trading at $1,712 per ounce, up from $1,600 at the beginning of 2012. Meanwhile, silver is currently at $35.20 per ounce, up from $33.50 in mid-February and near $29 at the beginning of 2012. Speaking of silver, in an exchange with Federal Reserve Chairman Ben Bernanke, Congressman Ron Paul recently brought up the comparable value of silver in relation to the US dollar...while shedding light on the fact that Bernanke does his own grocery shopping. Paul suggested that inflation is discouraging US consumers owing to an increase in the money supply. Paul: "This ounce of silver back in 2006 would buy over four gallons of gasoline. Today, it will buy almost 11 gallons of gasoline. That is preservation of value, and that is what the market has always said should be money."

While Paul brought up the issue of gas prices, inflation, and grocery bills, the issue of unemployment seems to be an albatross around the neck of the struggling-to-recover US economy. On Feb. 29, 2012, Zero Hedge discussed how "only 54% of young adults [18-24] in America have a job." As such, this number is the "lowest in 64 years, and 7% worse" than when Pres. Obama took office. The jobless rate for young Americans may portend politically-charged "American Spring" protests as we approach the 2012 election. We will likely be hearing more on this issue and its socio-economic implications going forward as we make our way towards November.

Thus, as we find ourselves in the twilight of the winter season, it is as if we are currently in the middle of a lull and the economic environment seems to be getting colder. Mark J. Grant recently wrote an interesting article for Zero Hedge arguing that we are in a lull "which has been caused by the injection of capital by the Fed and by the [European Central Bank]." Grant: "This is exactly, exactly, what took place, I remind you, during the weeks after the subprime mess exploded. Massive injections of capital, run-ups in equities, compression in bonds, higher prices for commodities and then the reversal, of course, took place."

Grant noted that in light of the end of Europe's quantitative easing, "when QE ended in America ... the stock market dropped approximately 50% in value so that as America ends its easing and Europe ends its easing the stock markets will not be such a great place to park money and this, coupled with a deepening recession in Europe, will play havoc with the world's equity markets in the next few quarters..." Per Grant's analysis, issues related to China, the end of QE in America and Europe, the threat of Iran, and other economic and structural factors portend that "we have been lulled into a state of lethargy by all of the printing of money, but long experience in the financial markets [teaches that] easy money has its consequences..." To say the least, Grant's analysis of Europe's prospects are quite bleak: "We are currently in the quantitative easing lull; nothing more." Grant's sentiments remind me of Mike Krieger's words at the end of his article from Zero Hedge on March 2: "Rest up this weekend everyone. I think things are about to get crazy."

Though the S&P 500 is currently at 1,369.63 as the Dow Jones Industrial Average flirts with 13,000, in light of the formidable economic headwinds that approach us, it would seem that the market is gearing up for a pullback. And just when it was starting to look like the recovery was at hand. Just when we thought that the winter was over, that the winter had spared us, it's starting to look like the global economic climate is going to start getting colder in the near future. With various issues including (but not limited to) unemployment, Iran, gas prices, inflation, and the Eurozone, one cannot help but feel that market observers are waiting for the other shoe to drop.

ACTION ITEMS:

Bullish:
Traders who believe that inflation is rising owing to actions by central banks might want to consider the following trades:

• Check out gold and silver in physical bars, coins, and ETFs.

Bearish:
Traders who believe that the stock market is going to experience a significant pullback in the near future may consider alternate positions:

• Short SPDR Dow Jones Industrial Average ETF DIA, iShares Dow Jones US Index Fund IYY, SPDR S&P 500 ETF SPY, and iShares S&P 500 Index ETF IVV.

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