Today the markets face a number of major headwinds.
1) Abenomics is failing. Inflation has risen in Japan, increasing the cost of living. At the same time period, incomes have fallen, as has household spending. And Year to Date the Nikkei is down over 14%, making it the worst performing stock market in the world thus far for 2014.
2) We are entering a period that has historically been very poor for stocks. According to the Ned Davis (NDR) database, had you invested $10,000 in the S&P 500 every May 1st starting in 1950 and sold October 31 of the same year, your initial position would only be worth $10,026 today in 2007. Put another way, by investing only from May through October, a $10,000 stake invested in 1950 would have only made $26 in 57 years.
3) The regulators are beginning to crack down on High Frequency Trading. While this is overall a very positive development for the capital markets, it will be removing one of the primary props for asset prices over the last five years.
4) The Federal Reserve is tapering the pace of its QE purchases. This is also very positive for the capital markets in the long-term as it lowers the Fed’s manipulation of the world’s risk profile. However, short term the tapering of liquidity will generally be market negative.
5) The market is sharply overbought and overvalued with a record number of investors bullish, margin debt at record highs, record high profit margins, and a forward valuation that matches that attained during the 2007 peak.
All in all, the market is facing an increasingly negative environment. Historically speaking April and May have not been big months for crises, but the number of negatives the market is facing today is rather unique.
Watch the key support line below. In particular, the key issue is how the market reacts if we break it. A sharp drop below followed by a strong bounce would maintain the momentum of the last two years. But if we break this line and fail to reclaim it… we’re in more serious trouble.
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