Wednesday, September 17, 2014

The Time For Caution Has Arrived

by Bret Jensen

I should feel good about the market today given my huge gains in Avanir Pharmaceuticals (NASDAQ:AVNR) yesterday. The shares rocketed up some 85% on positive Phase II trial results for its compound to treat agitation in Alzheimer's patients. The shares are now up some 150% since I provided a positive profile on the company in early May right here on Seeking Alpha in addition to my inaugural Small Cap Gems newsletter in July.

So why am I not happier with the market right now? Well, to begin with we have Jim Cramer yelling on CNBC this morning that equities currently have a horrid set up at the moment that feels like that before the huge "risk off" sell-off that occurred in early March. Ordinarily this would not bother me, but he is echoing some of my same concerns that I have recently noted on Real Money Pro.

The market has hit a major resistance point since the S&P 500 hit the magical 2,000 level earlier this month. This is something I predicted would happen at the time on Seeking Alpha. I believe the time for caution has arrived for investors especially those that have a good portion of their portfolio in "risk on" sectors such as biotech and small caps.

My biggest concerns for the overall market are the following:

Price action is deteriorating:

Monday was the perfect microcosm for the deteriorating price action in the market. The Dow Jones Industrial Average actually managed a gain yesterday and the S&P posted a small loss. However, both the more volatile and richly valued Russell 2000 and NASDAQ fell more than one percent yesterday.

Higher beta sectors such as biotech saw even larger gains. Individual high momentum names like Workday (NYSE:WDAY), Tesla Motors (NASDAQ:TSLA) and Salesforce (NYSE:CRM) were pasted yesterday and have been very poor performers over the last week. Until this action reverses, I would be reluctant to put more money to work in this part of the market.

(click to enlarge)

The End of Quantitative Easing:

The ending of "QE1" and "QE2" both triggered double-digit declines in the overall market. Investors are rightly cautious in front of the end of "QE3" in October. This latest version of QE added more than $1 trillion in additional assets to the Fed's balance sheet, which now stands at over $4 trillion from under $1 trillion before the financial crisis.

Unfortunately, this huge infusion of liquidity by the Federal Reserve has not had all the benefits the board anticipating. The economy has grown at a two percent annual GDP level since the recession ended in June 2009. This is less than half the 4.4% annual GDP growth the nine previous post war recoveries averaged coming out of a recession. It also pales against the 5.3% annual GDP growth we got after the last deep recession (1980-82) ended.

This easy money era also has had some perverse impacts. Corporations have utilized low interest rates to raise money to buy back stock and avoid paying additional taxes from repatriating cash from overseas. Companies bought back some $340 billion of stock in the first half of 2014. This is the highest level since 2007 right before the market started to turn down.

Smart Money is getting out:

In addition to robust stock buyback activity, both M&A and IPO activity are near 2007 peak levels punctuated by Friday's massive public offering of Chinese E-commerce giant Alibaba (Pending:BABA). If the so-called "smart money" consisting of venture capitalists and company insiders are cashing out, should retail investors be getting more comfortable allocating more funds into the market at these levels?

Slowing Global Growth:

The European Central Bank recently had to announce significant liquidity measures which some have dubbed "QE Lite" in order to keep the Eurozone from tipping into recession again especially in light of increasing sanctions on Russia. Italy already has recently suffered two straight quarters of contraction - the common definition for a recession. Not surprisingly, the Euro has continued its recent decline against the dollar, which will hit the earnings of American multi-nationals that get a good portion of their earnings from Europe when they next report quarterly results.

The Shanghai posted its worst one-day decline in four months overnight as Foreign Direct Investment just hit a four-year low. Iron ore prices remain dismal as this commodity is near four-year lows as well pointing to tepid global demand. A real slowdown in China is a "black swan" that I feel is likely at some point in the foreseeable future but few pundits talk about on a consistent basis. I just don't trust a government that states economic growth is consistently within 1/10 of one percent of GDP projections quarter after quarter.


I believe my cautious stance is warranted at the current time. I have a higher than normal allocation to cash within my portfolio at the moment. In addition, I have either exited or sold covered calls against most of my small cap positions. I will add reasonably valued blue chip stocks like Apple (NASDAQ:AAPL) or JPMorgan Chase (NYSE:JPM) on any significant dips in the overall market. Hopefully, by the end of the year it will be safe again to start moving back into some of the "risk on" sectors that seem primed for additional declines currently.

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