Daily Gains Letter

Why This Lofty Stock Market Requires an Abundance of Caution

By for Daily Gains Letter |

Why This Lofty Stock Market Requires an Abundance of CautionEven with some better economic news, it’s very important that investors not lose sight of the fact that the stock market is due for a massive correction.

The run-up since the beginning of the year is pronounced, but the stock market has basically been going up since the March 2009 low.

Corporate earnings are still being reported and, for the most part, the first quarter of 2013 was pretty decent.

It was very evident that revenues were light, but earnings at many companies beat consensus. What the numbers also revealed was a pronounced increase in cash balances at many brand-name companies. The financial health of U.S. corporations is getting better.

But with these fundamentals, the U.S. economy still has a long way to go in its recovery, and it’s important to view the stock market as a leading indicator that represents bets by institutional investors.

Institutional investors are paid to play. When they take in money, it has to go to work, because that’s what customers are paying for.

Corporations are also playing their role in this rising stock market. They’ve been very good at managing their earnings and satisfying what shareholders want—that is, earnings maintenance in a slow-growth environment, increasing share buybacks, and rising dividends.

What I gathered from first-quarter earnings season is that many corporations expect the bottom half of the year to be stronger.

It’s my view that institutional investors are betting on this expectation, because they have cash inflows that need to be put to work.

I’m actually quite surprised the stock market has not corrected already. Like earnings, the flow of economic news has some momentum, but a significant pullback is required for the technical picture to remain healthy.

While it certainly is great that share prices are going up and investors are making money, I view investment risk as continuing to be high.

The month of March did show some weaker economic news, but that was expected by the marketplace. If April reverses this trend, then the stock market can go higher and a “sell in May and go away” strategy will get pushed out.

For investors with an existing stock market portfolio, first-quarter earnings were solid, but it really is difficult to step up to the plate and be a new buyer.

An abundance of caution is still necessary. Current stock market action suggests that everything is a “hold.”

This market needs to correct very soon, or it will definitely be overbought.

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