Friday, August 9, 2013

How will stocks react to less liquidity?

Much of the 2009-2013 stock market recovery was due to the stimulus provided by the Fed, so it’s only natural that investors wonder if the eventual withdrawal of that stimulus – possibly later this fall – will lead to a retreat in stock prices. 

Interestingly, the market isn’t as panicked this time around as it was in May when it was first suggested that QE3 would soon be winding down.  It’s possible that investors are becoming inured to this suggestion, yet a more likely explanation is that they simply don’t believe it.  After all, they were told this spring that QE3’s days were numbered only to hear the Fed backtrack and change its mind.  My guess is that until they see that a wind down of the stimulus is imminent, investors will remain skeptical.

By the time the tapering finally begins, however, it’s entirely possible the market will have already undergone a prolonged topping process.  Usually before the major indices make a final top the market spends several weeks-to-months topping out internally, that is, a few industry groups begin declining even as the leading industry groups continue advancing.  This process could already be underway as suggested by the dominant intermediate-term internal momentum indicator shown here. 

While most growth-type stocks haven’t topped out yet, the market is showing considerably more internal weakness when viewed from the standpoint of the commodity-related industries, homebuilders and REITs, and of course China ADRs.  [Excerpted from the Aug. 7 issue of MSR]