Trademark Market Perspective for 4/15/13, Mark Carlton, CFA

On April 3^rd I wrote a bulletin cautioning that the recent behavior of the stock market (new highs but with fewer stocks participating) was characteristic of market tops.  The market subsequent declined for three days before turning around sharply and making new highs.  Obviously this negates the near term technical warning, though I am not ready to say full steam ahead.   The huge gain on April 10^th in the stock market was accompanied by an advance-decline ratio of 4:1.  This is good, but not at all as good as the 9:1 advance/decline ratio we saw back on January 2^nd.

Moreover, neither the Russell 2000 (small cap stocks) nor the Dow Transportation Index confirmed the new highs made by the Dow Industrial Average and other large cap indices.[1]  My reading is that we are late in the stock market advance, but not in the “bottom of the ninth” like I feared back on April 3^rd.

Seasonally, the U.S. stock market tends to peak sometime between the fourth week of April and Memorial Day.  Things may be a little different this year.  Money is currently pouring in from Japan due to the yen carry trade.  Briefly, a “carry trade” involves borrowing in a weak currency (in this case the Japanese yen), and investing the proceeds in assets denominated in a stronger currency to thereby capture both the return on the non-yen asset and the gain in the currency you invested in versus the yen.  An effort to stimulate that Japanese economy that is unprecedented in relative magnitude by the Bank of Japan has enabled, for the time being, both global bond and stock markets to rise simultaneously.  It should be remembered that monetary stimulus is not a free lunch.  Either the excess liquidity will be drained at a future point (in which case we will have pulled future stock market gains into the present, reducing or completely eliminating the gains we should have expected at that time), or it won’t (in which case we will have higher inflation, likely high enough to create a different set of problems – especially for bond investors).  Increasingly world central banks/politicians seem to be playing a game of sacrificing the future for the benefit of the present.  It won’t end well.  The issue for investors and advisers is this – even if we are aware that we are going down a very perilous road, if we believe we are going to earn the vast majority of the market’s next 5-10 years of return this year, can we afford to get too defensive too soon?