A Time for Caution

The Dow Jones Industrial Average has more than doubled from its bottom of 6,400 in early 2009, closing at 15,115.57 on May 31st 2013. The US Federal Reserve engineered the bull market by injecting cash into the markets in early 2009. The program is called quantitative easing. The way it works is that the Fed buys US Treasuries and mortgage- backed securities from primary dealers (banks) and mortgage holders. When it does this it credits the bank balance sheet with cash for the securities. This creates new-found money for the banks and mortgage lenders to work with. For the most part the banks have not done much lending with this money. Instead they have been speculating in the markets, driving the prices of stocks and bonds to new all time highs. This is the underlying driver for the stock market. To date the Fed has injected nearly $3 trillion into the markets. Under the present program the Fed is injecting $85 billion per month by buying $40 billion of treasuries and $45 billion of mortgage backed securities. The key flaw in this program is that the money that the Fed printed has not reached the average American. The banks and large institutions have hoarded the money. What we have now is a gap between the big market players and the real economy. The hype and media coverage for the past four years is under a microscope.

A recent study by the St. Louis Federal Reserve pointed to fact that the average American has only recovered 45% of the monies lost in the Great Recession. Unemployment is too high and the consumer has had to spend more on the basics of food and energy. While home prices have recovered somewhat they nowhere come close to regaining the 30% loss when the market collapsed.

An added factor is speculation concerning when the Fed will taper its bond and mortgage backed securities buying. If that happens there will be less new money coming into the economy. We are seeing all of these market forces coming together, Investors are trying to decide how best to protect their profits, whether to stay in the market or sell some or all of their holdings. By all accounts as long as the Fed continues its bond and mortgage- backed securities buying, this market still has some bullish legs.

However other indicators point to a possible correction. Traders who watch technical indicators have seen the VIX index jump up over the past week. The VIX is a measure of market volatility. When it goes up you can expect a bumpy ride with wide market swings. On Friday the VIX jumped +1.77 to 16.30.

Another carefully monitored indicator is the Put/Call Ratio. It measures the number of put options purchased on the S & P versus the number of call options purchased. That index is at a 2½ year high, also indicating that investors are taking protection against a market decline.

Also keep an eye on the DOG. This is an inverse ETF on the Dow Jones Industrial Average. It has dropped steadily over the past few years mirroring the rise in the Dow. Now it may be forming a bottom.

It is too early in the game to jump on the sell side with both feet. The Fed still has enormous power to inject new money in the economy.

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