The Two Things That Could Kill The Current Market Rally

Business Insider

The consensus view on Wall Street is that the stock market – specifically, the S&P 500 – will appreciate around 10 percent in 2013.

Moreover, there is very little deviation from that consensus among Wall Street strategists.

However, even though everyone seems to agree that stocks are set for a pretty good year in 2013, no one is really predicting that they move up in a straight line – especially in the first half of the year.

After all, the S&P 500 has already rallied around 9.5 percent since mid-November, and many are waiting for a correction.

Credit Suisse strategist Andrew Garthwaite recently identified eight sentiment indicators at or near multi-year highs that suggest investors have gotten too bullish too quickly, and thus a correction may be at hand.

Goldman Sachs has the same idea, and the chart below – wherein Goldman strategists predict a dip in the market in the first quarter – is pretty representative of the general vibe on Wall Street.

In a note to clients today, BofA strategist Michael Hartnett echoes this storyline. He also suggests two catalysts for the selloff everyone is waiting for:

(1) 1994 redux (liquidity surprises on downside)

As we have highlighted recently, asset returns in 2012 were eerily similar to returns in 1993, the last time we emerged from a long recession/jobless recovery. Banks were the best performing sector in 2012 for the first time since 1993, heavily hinting that deleveraging is coming to an end.

While the Fed has committed to maintain its easing program, US homebuilding stocks hint that policy will not stay easy indefinitely (chart), and the bond market is likely to overreact should a strong payroll figure (check out what happened in February 1994) suggest a sharper drop in the unemployment rate this year.

(2) The “Fiscal Whiff” and a currency war

While DC’s fiscal philosophy is broadly “no pain, no pain”, taxes have decisively risen in the US and we worry weaker consumption growth could cause a weaker US dollar. Alternatively yen depreciation could accelerate to the point of raising JGB yields sharply

Either way, it is clear that many nations want/need a weaker currency – should China also feel the need for a weaker FX (watch CNY and ADXY) then the risks of a risk-negative FX war would start to grow. Gold would rally sharply, but note a rise in gold prices and a fall in bond prices precipitated the 1987 crash. 

Says Hartnett, "Now that there is seemingly nothing left to worry about, perhaps it may be a good time to start worrying."



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