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6 Worries Shaking the Market

Factors from the U.S. economy to Iraq and the Ukraine are finally starting to rattle the bulls

This historic stock market melt-up of the past few weeks has given way to a new bout of fear and uncertainty. The Dow Jones Industrial Average is tumbling back toward its 20-day moving average for the first time in a month. And the lift we saw after the European Central Bank cut its deposit rate into negative territory has been reversed.

Sentiment had reached historic extremes, on many metrics hitting levels not seen since the 2007 and 2000 market tops. The bears went into hibernation.

But now, a cavalcade of concerns has the bulls in retreat. Let’s take a look at them.

The Economy

Economic indicator retail chart
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The gap between hope and reality could be clearly seen in the way Wall Street analysts and investors had started to take as gospel the idea that the economic weakness seen in the first quarter was merely due to weather (Barclays Capital is looking for Q1 GDP growth to be revised down to a -2% contraction) and that an epic rebound in activity will soon be upon us.

Yet as recently as late May, analysts were looking for the economy to surge 3.5% in the second quarter.

Unfortunately, weak retail sales data out Thursday morning is calling that into question. Month-over-month growth was less than expected and so-called “core sales” less autos and gasoline were flat. The consensus was looking for a 0.5% rise. The trend, illustrated by clothing sales shown above, isn’t good and is calling into question the GDP optimism baked into the market at these prices.


economic indicator unemployment chart
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Investors have similarly been very optimistic about the path of corporate earnings growth going forward as well as the valuation multiples assigned to those earnings.

The Street is looking for 5.4% in Q2, up from 2.1% in Q1, before accelerating to 9.7% in Q3 and 10.3% in Q4. That 10.3% figure is actually an improvement from the 9.9% expected at the start of the year. And according to Bank of America Merrill Lynch, analysts are now making more positive than negative revisions to earnings for the first time in two years.

On valuations, Bloomberg recently noted that the S&P 500 is now trading at 16.5 times forward earnings (with expectations quite optimistic) vs. 14.8 at the start of February. Moreover, Bespoke Investment Group highlighted that the S&P 500 was recently less than 20 points away from the average year-end target of 20 Wall Street strategists.

The problem is that corporate profitability will be challenged not only by the softness of the overall economy (which will hit revenues) but also from the rising labor costs associated with a tighter job market. Just look at the short-term unemployed as a share of the population (chart above), which is down to levels not seen since the 1950s. These are the folks businesses like to hire first.

No wonder more and more businesses are complaining of a labor shortage and are reporting higher labor costs.


economic indicator light crude oil chart
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In headlines seemingly ripped out of the Bush Administration era, Iraq is back in the news as an army of Islamic militants have captured two major cities in the north (one, Mosul, is Iraq’s second-largest city), captured hundreds of millions of dollars from a central bank branch, and have forced the displacement of more than 500,000 citizens. The extremists are from an organization known as the Islamic State of Iraq and the Levant (ISIL), also referred to as the Islamic State of Iraq and Syria (ISIS).

ISIL reportedly has taken the country’s largest oil refinery and have threatened to march on Baghdad.

An outright civil war is a rising threat as Iran reportedly sends elite commandos to bolster Baghdad while the Kurdish forces expand their control by taking oil-rich Kirkuk.

Crude oil has soared to nearly $107 a barrel in response — level not seen since last September — complicating the situation by pressuring already vulnerable consumers, pushing up inflation (which is already at the Federal Reserve’s 2% target), and potentially forcing short-term interest rates to rise sooner than expected.


economic indicator rsx chart
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Pushed off the front page but not forgotten, the situation in Ukraine took a turn for the worse Thursday. Natural gas negotiations between Kiev and Moscow broke down amid reports that Russian “rebel” tanks are crossing into Ukraine.

Russia also upped the political pressure on Ukraine by introducing a draft resolution to the UN Security Council condemning Kiev’s alleged attacks on residential and civilian facilities in the east.

In sympathy, the Market Vectors Russia ETF (RSX) looks like it could be ready to drop back below its 200-day moving average.


The upcoming 2014 midterm elections look like they could be even more exciting in the wake of the surprise primary loss of House GOP Majority Leader Eric Cantor to a tea party-backed candidate. Whether this is indicative of a broader shift to the right or perhaps an energized Republican base remains to be seen.

But if the GOP takes the Senate, we could see another round of bruising battles between Congress and the White House of issues like the record deficit, the $17.5 trillion national debt, and more that could rattle markets — as it did in 2011 after the GOP, energized by the tea party, took the House.


economic indicator rsx chart
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I’ve written before about the importance of yen carry trades in the market — where hedge fund types have used a weak yen to fund speculations in stocks and bonds. It has been a major support of stocks over the last few months, but it’s starting to unwind now.

There are many reasons for this, from inflation beginning to bite in Japan to Europe’s new stimulus push, but what you need to know is that earlier Thursday, the S&P 500 reached a statistical correlation of nearly 97% with the dollar-yen exchange rate. That means that nearly 97% of the tick-by-tick movement in the stock market was explained by what was happening in currencies.

Not only is that not normal, nor is it healthy, but it’s also dangerous given the technical breakdown I’m seeing in the yen carry trade, with the euro-yen exchange rate in particular collapsing out of a multimonth consolidation pattern.

That will weigh not only on U.S. markets, but Japan’s as well in the overnight Asian session.

What’s next?

economic indicator euro chart
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Given the extreme low volatility/extended sentiment behavior of the market lately, the arrival of all these negative catalysts is likely to have a large impact on overconfident investors.

You’re seeing that in Thursday’s scramble into safe haven assets like the CBOE Volatility Index as well as precious metals. The Market Vectors Junior Gold Miners (GDXJ), which I’ve recommended to my newsletter clients and discussed in a recent article, soared 5.8% as it jumped over its 200-day moving average for the first time since February.

I think gold and silver could really get a run going here not only on the geopolitical situation but also on rising inflation expectations.

Recent recommendations to clients and readers include New Gold (NGD), up 5.6% Thursday and up 11% since I added it to my Edge Letter Sample Portfolio on June 5.

NovaGold (NG) is up nearly 15% during this time.

Disclosure: Anthony has recommended GDXJ, NGD and NG to his clients.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.

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