Is the Market Setting Up for a Crash?

By Sasha Cekerevac for Investment Contrarians | Aug 1, 2012

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While the economic data have continued to come in worse, the S&P 500 has strengthened over the past few months. What is the stock analysis that can justify such a move, and is it sustainable? These two questions are critical for those interested in investing in stocks. There are several reasons for why the S&P 500 is at current levels, and it starts with how stock analysis is conducted.

The first thing to remember when investing in stocks is that the market is a forward-looking mechanism. That means that the current economic environment is not as important as what will happen 6–12 months or more into the future. Proper stock analysis needs to take this into account and try to understand where the winds will be shifting.

Even in this weak world economy, there are several points of interest for those interested in investing in stocks. First, we have central bank activity. Question: is it more or less likely world central bankers will be adding monetary stimulus before the end of the year? I think it’s quite apparent that at least some central bankers will be increasing monetary stimulus. This is seen as a positive when conducting stock analysis.

While the Federal Reserve might wait for the September meeting to enact further monetary stimulus, if that were to occur it would be a positive when it comes to stock analysis. I also think the European Central Bank (ECB) and even the Chinese financial authorities will also add additional monetary stimulus; again, these are further positives when it comes to stock analysis.

A huge worry for those interested in investing in stocks is how to calculate the upcoming fiscal cliff. With the year end approaching, I believe there is no chance that a deal won’t be finalized. It is in neither party’s interest to cause a recession next year, and because of this, I believe that a deal will get done. This will be a very positive action for the market and one that needs to be accounted when performing stock analysis. This uncertainty has been weighing down the markets and concerning those interested in investing in stocks. With this concern alleviated, the market would most likely move up.

The real concern is what happens when the additional monetary stimulus is added. There’s a good chance that the market might be poised for a “buy on the rumor, sell on the fact” reaction. Stock analysis is difficult to begin with, having gone through so many rounds of monetary stimulus already, and with so little effect, the market might be worried that there won’t be any positive reaction.

Investing in stocks is all about trying to figure out what is most likely to happen in the future. If this next round of monetary stimulus fails to kick-start the world economy, we could be in for a very big selloff. Time will tell, but I would be cautious with my stock analysis. If the market breaks below key technical levels, I’d head to the sidelines and protect my assets.

Tags: Federal Reserve, investing in stocks, monetary stimulus, Recession, stock analysis