We’ve been looking for short-term strength in stocks ahead of a decline over the summer, but the short term is draining away quickly without much stock strength to report.
Several factors suggest that a market breather is in order. The effect of stimulus is wearing off as shown by tapering earnings growth at companies, a still moribund housing market, and tempered economic data. Plus, the Federal Reserve is preparing to wind down QE2, which has provided upward pressure for the past half year. Moreover, the bull market was a farcical affair all along, goosed by unsustainable liquidity and shady “booster buying” whenever downturns appeared imminent.
Turning to market internals, we looked last Sunday, May 15 at how cyclical sectors such as financials and technology have taken a backseat recently to defensive sectors like healthcare, consumer staples, and utilities. “That switcheroo is a red flag” signaling defense to be the watchword of the day, I wrote. That persisted last week. The weak-dollar-boost is waning for cyclicals while defensive sectors increasingly top analyst buy lists. Such patterns coincide with economic weakness and, ta-da, that’s what last week’s economic reports delivered.
Thus, we’re ramping up our defense.
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