Credit Bubbles And Market Highs

By seadmin

There’s simply no denying it. The Dow Jones Industrial Average and S&P 500 have been on a roll lately. Well, at least they were on a roll before today’s action. On Tuesday, the Industrial Average broke above the psychologically significant 14,000 mark for a brief time. But by the end of Tuesday’s session, the index had retreated to close below 14,000.

Why didn’t stocks resume heading higher today? Well, one reason is that markets this extended are bound to pull back at some point. But perhaps the more substantive reason was the news out of Bear Stearns.

The investment bank announced this morning that some of its hedge funds now are essentially worthless due to bad investments in subprime mortgage debt. In the past, we’ve warned you about the potentially hazardous side effects in the financial sector due to problems with bad mortgage debt. I think that if this subprime mortgage debt mess becomes contagious, we likely will see it have a deleterious effect on the entire market.

Perhaps as interesting as the warranted pullback today in stocks is the rather perplexing reasons why this market has become so overbought. Check out the following quote that I read this morning from an Associated Press article about today’s market action.

"With no major catalyst behind the advance, the record run has perhaps been puzzling to market watchers trying to determine if it has room to build or has run its course."

I think this comment pretty much tells it all when it comes to this market.

I can say honestly that predicting what may happen with stocks lately has been a real challenge. Stocks continue climbing, and the usual catalysts have not been the chief reasons for these new highs.

What we have to ask ourselves here is will this rally continue or is today’s pullback the beginning of what I think is a much overdue correction? Of course, nobody knows for sure, but let me share with you part of a conversation that I had with David Tice, portfolio manager of the Prudent Bear Fund (BEARX).

"We believe that the environment is getting much worse, and this recent rise in equities is completely undeserved," said Tice, commenting on the current condition of stocks.

The real concern that David has right now — a concern that I certainly share — is the subprime mortgage fiasco and its potentially negative effect on the markets.

"The subprime mess is a microcosm of the greater credit system. The Bear Stearns hedge fund mess is a great example. We expect there will be lots of institutional players asking for redemptions from hedge funds which played in this area, which will cause more forced sales," Tice predicted.

David thinks that now is a great time to short this market, especially with stocks at such vaunted levels. My feeling is that if the S&P 500 can remain above 1,520, then we have a good chance of stocks climbing higher despite these record levels. If, however, we fall below 1,520, then it could spell big trouble for stocks ahead.

Right now in my High Monthly Income advisory service, I am in a fund that is profiting from the current conditions in the credit markets. I also am positioned to take advantage of rising energy prices and the falling U.S. dollar. Finally, in the event that the equity markets start to fall back down to earth, one of our funds is set to go sky high.

For more on my High Monthly Income service, click here.

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