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3 New Reasons The Case For A BIG BEAR Just Got Stronger

March 30th, 2011

The risks of investing in most U.S. stocks have been extremely high for a host of reasons:

Interest rates have been rising nearly nonstop since August 2010. Energy and food prices have catapulted sharply higher. The U.S. housing market has been declining relentlessly. The labor market has been in dire straits with new hiring stagnant. Plus the stock market has been severely overvalued and overbought.

I’ve outlined these arguments in previous Money and Markets columns. And they are no less valid today. But now, the case for a bear market just got a lot stronger.


Three New Bearish Developments

First, QE2 will soon be history, and QE3 is becoming more and more unlikely.

You may well remember Fed Chairman Ben Bernanke bragging about how a rising stock market — especially small caps — was a result of his quantitative easing. Well, I agree. The stock market rally since last summer has indeed been based almost entirely on the Fed’s quantitative easing — outright money printing that merely encourages more risk taking and speculation.

But he also said this is a “positive” outcome, and on that score I think he’s dead wrong. Gains that are bought and paid for by the Fed’s funny money are nothing more than a speculative bubble that’s prone to a bust much like tech stocks in the late 1990s or housing in the mid 2000s.

As long as Mr. Bernanke can keep the funny money flowing, this aspect may be papered over. But now various Fed officials have stepped up and spoken out against an additional round of quantitative easing.

So when QE2 has run its course and hopes for QE3 vanish, there will be nothing left to support this levitated, overvalued stock market.

Second, inflation and inflation expectations are on the rise.

Outside of the U.S., inflation is actually old news. It has been obvious for quite some time that inflation is the inevitable consequence of reckless monetary and fiscal policy. Now, for the first time in nearly three decades, it’s also becoming more obvious in the U.S. as well.

The chart below shows just how price pressures are starting to creep into the U.S. economy; and as usual, producer prices are first in line to feel the heat, with consumer prices sure to follow.

Producer Price Index

That’s very dangerous for the stock market. Why? Because history shows that stocks perform very poorly during times of rising inflation. And a fast change in inflation expectations has triggered some of the worst bear markets in history — especially when markets were overvalued!

If this relationship still holds — and I can’t imagine any reason why it shouldn’t — U.S. stocks will soon be in for a nasty surprise.

Third, consumer sentiment has just taken it on the chin.

The University of Michigan Consumer Sentiment Index plunged from 77.5 in February to 67.5 in March. Drops of this magnitude are rare. But when they happen, they send the message: Look out below!

Michigan Consumer Confidence

As you can see in the chart above, this indicator’s history is impressive …

There was a similar large drop in August 1990, another in September 2001, and a third one in October 2008. All three were associated with recessions and turned out to be big sell signals for the stock market.

Has this indicator ever been wrong?

Only once in recent years, but for a good reason: Consumer sentiment gave a false signal in September 2005, when Hurricane Katrina hit U.S. shores. But there’s no such event today and no excuse to ignore this indicator.

Bottom line: I continue to recommend caution. Plus, consider some insurance in the form of inverse ETFs, like ProShares Short SmallCap600 (NYSE:SBB) in the $27-$28 range. This fund is designed to rise in value when the S&P SmallCap 600 Index 100 declines.

Best wishes,

Written By Claus Vogt From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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