With the S&P 500 having soared 27% in the last 5 months, this market seems to be headed in only one direction. No meaningful market correction has been made in this 5 month period, which has skeptics such as Doug Cass of Seabreeze Partners believing the rally is due for correction.
To further highlight his case, Cass lays out 4 potential reasons why the rally could come to a grinding halt;
1. The recent decline in the Emerging Markets, made most evident in the EEM ETF, which has seen a correction of over 5% since its 52 week, while the US markets i.e. The Dow Jones, the S&P 500 and the NASDAQ hit new 52 almost on a daily basis. A recent article in the FT highlighted that there had been a massive $7bn outflow of capital from emerging markets. This historically has been a leader indicator of a pullbacks in the developed market. The one question he asks is "if emerging markets are the worlds economic drivers, then why are investors pulling out"?. However one possible answer could have been the political uncertainty, which has developed in the Middle East in the last month.
2. Cass also highlights that even though Mubarak has been overthrown, there is still a substantial amount of Geopolitical mess in the region with no clear solution in sight. Additionally further uprisings are very likely, especially in Yemen and Algeria the consequences of which are unknown.
3. Raw Materials Inflation - Cass feels that investors are presently ignoring the impact of higher input cost, which have been brought attention most recently in PepsiCo's earnings report http://www.nytimes.com/2011/02/11/business/11pepsi.html?_r=1&partner=yahoofinance. This will inevitable have an impact on companies gross margins or alternatively prices will be passed onto consumers, which will have a trickle down effect on the overall economy as they cut personal spending.
See charts here:
4. Lastly, he highlights "the rate of the rise in bond yields may be nearing a tipping point" - he then goes on the say that he is a little concerned by how the futures market indicates a lower market in the morning but then by the close, equity markets are positive. At some point the train has got to come of the track.
Also the fact that trading volume as been pathetically low for some time now is another sign of potential weakness in this rally, on Friday for example only 7.7bn shares changed hands compared to last years average at this time of 8.47bn. This is a possible sign of waning investor interest as the market continues to trade in narrow range, with a steady upward momentum.