Stock Market Bubble Grows Bigger

For the week, the U.S. stock market and its major indexes, the Dow Jones Industrial Average (DIA) and S&P 500 (SPY) set new all time highs again in the face of poor economic news and weak earnings reports.

For the week, the Dow Jones Industrial Average (DIA) rose 1.6% and the S&P 500 (SPY) gained 2%. The Nasdaq (QQQ) added 1.8% for the week.

All major indexes remain overbought and in record territory according to several technical indicators.

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In the chart of the S&P 500 (SPY), we can see how the index has returned to overbought territory with RSI above 70 and the index now far above its 50 and 200 day moving averages.

This major stock market index is now 12.8% above its 200 day moving average, an extreme not seen since March, 2000, just before the onset of the dot-com crash. Margin interest is near record highs and earnings have been mediocre, at best, and in recent days various Fed officials have been hinting that a step back from quantitative easing could be coming soon.

All of this adds up to a continued high risk environment for the stock market in an overbought, bubbly environment.

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Economic reports were mixed last week as retail sales grew 0.1%, beating expectations and consumer sentiment and leading indicators rose on Friday.

However, the negative news far outweighed the positive as weekly jobless claims unexpectedly spiked higher, the Empire Index fell into negative territory, vastly missing expectations, industrial production declined, also missing expectations, and the Philly Fed took a sharp tumble into negative territory. Reports from Europe indicated that the Eurozone recession is deepening with nine of seventeen countries in recession. The European economy fell 0.2% in the first quarter and now has been in recession for six straight quarters. Even powerhouse Germany managed to just barely stay out of recession with a gain of 1/10% in the first quarter.

Earnings reports did little to add cheer as Dell Computer was hit with a 79% drop in earnings, JC Penny reported a $350 million loss in its first quarter and Walmart saw same store sales dropping and earnings missing expectations as consumers hunkered down in the face of ongoing high employment and higher payroll taxes.

Next week brings some important economic reports but the big headlines will come on Wednesday when the Federal Reserve’s meeting minutes are released. A recent stream of comments from Fed Presidents that the Federal Reserve should start backing off on quantitative easing could be setting the stage for some unsettling comments in the upcoming minutes. Market participants will be keeping a close eye on Fed Chairman Bernanke’s testimony to Congress on Wednesday for hints over the future of quantitative easing and the Fed’s future plans.

Numerous analysts and commentators have agreed that the recent rally is largely based on easy money supplied by the Fed and that investor reaction to removal of the “punch bowl” could be highly negative.

Other important reports will be weekly job claims, Markit PMI and new home sales on Thursday and durable goods orders on Friday.

Bottom line: The stock market bubble grows bigger as investors continue to believe that the Federal Reserve will not cut back on its quantitative easing programs, even as warnings emerge. Coupled with overbought conditions and a slowing global economy, the stock market remains in a vulnerable situation.

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