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Are Stocks Making a Major Top?

With the often misused term "overbought" being thrown around regularly on Wall Street these days, it is a good time to take a step back and assess the odds of a new bear market rearing its ugly head from current conditions.

Some on Wall Street make decisions based on economic fundamentals; some use technicals, and others use both. In terms of helping discern between favorable market conditions and unfavorable market conditions, fundamentals and technicals are both important. Bull markets tend to have favorable fundamentals and technicals backing them. Bear markets almost always are associated with weak or negative economic growth and corresponding weakness in the technical state of the markets.

Fundamentals

From a fundamental perspective, experienced investors know the periods shown below were less than friendly in terms of returns. Stocks tumbled in July of 1990. Bear markets were wrapped around economic weakness in 2001, 2008, and 2009.

GDP Growth

Do we have fundamental conditions in place to suggest a major stock market top is around the corner? Said another way, is there a realistic chance of negative GDP growth occurring in the next several quarters? The Wall Street Journal's annual survey of the best economic forecasters produced favorable responses on the economy's prospects in 2011. Similar upbeat results are contained in the latest Blue Chip Economic Indicators survey. The consensus in both surveys is that the economy will grow by at least 3% this year; hardly what we would expect to usher in a new bear market. We do respect (a) forecasting is difficult, and (b) things can change over the next few months, but for now the fundamental outlook remains bullish.

With the Obama Administration looking to increase exports, the recent acceleration in manufacturing activity was encouraging. In the latest ISM survey, the PMI composite index rose 2.3 points to 60.8, the highest level since May 2008. Economists expected a slight decline to 58.0. A 5.8-point jump in new orders to 67.8 represents the best level in seven years. Employment increased 2.8 points to 61.7, the highest reading since the spring of 1973.

Recent data also points to more responsible lending practices in the housing market. According to Freddie Mac, cash-in deals rose 11 points to 46% of all refinancings in Q4, the highest share since data began in 1985. Cash-out deals fell to a record low 16% of refinancings.

Some hints of an improving labor market have surfaced in 2011 as well. Online help-wanted postings jumped a record 11.4% in January 2011, representing the best level since the summer of 2007. New help-wanted postings jumped 16.1% (best since July 2008). Historically, these figures align well with employment gains in the coming months.

If the fundamentals do not align with the onset of a new bear market, what about the technicals? We cover that side of the ledger in Is The Stock Market Extremely Overbought?

 

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