End of QE2 Is a Tipping Point

06/29/2011 7:30 am EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

There are still plenty of hurdles before established and emerging markets are out of the woods, so you're best choice is to continue to play it safe, write Pamela and Mary Anne Aden of The Aden Forecast.

Stock markets around the world are starting to crack. They’re all being pressured by weak economic signs, from the US to Europe.

This is adding to growing concerns that the global economy is going to slow down further.

The situation in Greece was initially a big damper on stocks. Combine that with ongoing financial concerns in Portugal and Italy, plus the biggest election defeat for Spain’s ruling party in 30 years.

As June got underway, the market was hit hard when US bonds rose sharply. As you know, the bond market tends to be a reliable leader for the economy, and so are stocks.

But when bonds surged on June 1, following a string of signs reflecting a struggling economy, it spooked the stock market. Stocks took this as a confirmation that the economy is indeed in trouble, and the market quickly followed bonds' lead.

Not helping matters, QE2 is due to end tomorrow. And we know this liquidity has clearly pushed stocks higher. So the stock market was likely looking ahead, as it usually does, and the thought of no more stimulus, together with what it sees happening around the world, was too much to accept, tipping it to the downside.

Were the Emerging Markets Leading the Decline?
Interestingly, as we’ve noted before, the emerging markets, as a group, haven’t been as strong as US stocks this year. You’ll remember they were the superstars, but this year they’ve been lagging.

Strength then switched to the US market and some of the other developed countries, like Germany. But the evidence of a slowdown has recently been fairly consistent, and it’s now looking like the emerging markets were probably leading the rest of the markets.

Market Is Bullish…But Beware
For now, the major trends remain up for the US and many of the other stock markets, but the market internals are weakening.

In other words, so far this is still a downward correction. Nevertheless, there are some important signs we’re watching closely…

The Dow Jones Transportation Average, for instance, is clearly resisting at its 2007-08 high, which is a very strong resistance level. Most of the major stock indices have also declined below their medium-term moving averages.

Plus, June is historically a bad month for stocks, and we’re certainly seeing this pattern repeat. This adds credence to the argument that the stock market will not be able to make it on its own without a QE fix of some type.

Many respected analysts are warning that another financial crisis could be on the horizon similar to the one in 2008. They claim that since the 2008 meltdown was not allowed to end naturally, the conclusion is still coming.

This is a real possibility, since the fundamental, underlying factors that triggered the crisis to begin with still persist. Another possibility is just a renewed recession.

Time to Take Some Profits
Meanwhile, we have to remember that US stocks haven’t been very attractive to foreign investors. Even though stocks have risen in dollar terms, they’ve been declining in euro terms since 2002, thanks to the weak US dollar.

On the other hand, with a good part of the world facing financial difficulties, there aren’t many safe havens left. Investors don’t know where to turn, which is one good reason why gold keeps rising.

When push comes to shove, however, the US is also seen as a safe haven—and that alone could keep a buffer under the stock market.

If the world moves into recession, it’ll be another story. All stock markets will suffer, some more than others. Investors could then shift from stocks to bonds, which are considered a better haven, and this appears to be what may be upcoming.

All things considered, we feel this is a time to play it safe and lighten up on your stock holdings.

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