Eight Contrarian Signs That Call a 2011 Stock Rally Into Doubt

Contrary signs about a 2011 stock rally
Contrary signs about a 2011 stock rally

Expectations for a continued rally in U.S. stocks in 2011 are front and center, and the reasons for the ebullience are numerous: U.S. GDP growth has returned to prerecession levels, and consumer confidence and sales are both rising.

But beneath the bullish sheen of positive consumer sales, a number of key statistics and indicators are bearish or neutral. Investors might want to balance the widespread confidence in a 2011 rally by looking at these indicators:

1. Industrial production and capacity utilization have both stalled, according to Federal Reserve data. The Ceridian-UCLA Pulse of Commerce Index has declined from the second-quarter highs, suggesting the recovery that began in mid-2009 has flattened. As this chart illustrates, the Ceridian Index turning down is a negative indicator for future growth.

2. The Baltic Dry Index (BDI) has been in a downtrend since June. The BDI is generally viewed as a reliable proxy for the global shipping industry. When demand for shipping is strong, the BDI rises; when demand to ship goods falters, the BDI declines. There's simply no way to interpret the BDI's steady deterioration as a bullish reflection of rising global trade. Rather, the declining BDI suggests global demand for shipping is slipping significantly.

3. Interest rates are rising. Despite the Federal Reserve's stated goal of maintaining a low interest rate environment, rates have risen sharply recently. Rising rates increase the cost of doing business and are generally viewed as negative for housing because rising mortgage rates mean potential homebuyers will be paying more per month.

4. Oil and gasoline have risento levels that some analysts see as negative for growth. There's a contradiction in rising oil prices: Though higher demand is considered evidence of strong economic growth, more expensive oil acts as a broad-based "tax" on the overall economy. The incomes of consumers and enterprises are reduced as more of their money is diverted to pay for oil, gasoline and diesel fuel. That leaves less money for consumers to spend on other goods and services.

At least some analysts reckon that oil breaching $90 per barrel negates the modest growth in GDP registered in the previous quarter. This chart of the U.S. Gasoline Fund, a proxy for the cost of gasoline, illustrates the sharp, sustained rise in fuel prices since August.

5. Property taxes and other state/local taxes are rising. As I documented here recently, property taxes are rising despite the deep declines in property values. Faced with massively underfunded pension obligations, state and local governments are passing significant tax increases -- often over 10% per year. These tax hikes reduce the effectiveness of the recently passed federal tax cuts as a form of economic stimulus.

6. Retail investors are shunning U.S. stocks. Spooked by the 40% declines in the stock market in 2008-2009 and the "Flash Crash" in May 2010, noninstitutional investors have been pulling their money out of U.S. markets. This lack of participation means fewer buyers are available to drive stocks higher.

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7. Margin debtis at the highest levels since September 2008. A reflection of strong appetite for risk, margin debt is based on the cash value of a brokerage account portfolio, and when investors borrow against their portfolios to buy more securities, it's generally seen as bullish. As stocks increase in value, then the amount an investor can borrow on margin also increases.

The potential downside of high margin debt is severe: If stocks swoon, investors with heavily margined portfolios receive a "margin call," which requires either an infusion of cash into their account to compensate for the decline in value, or the sale of securities to reduce the margin debt. Margin-induced selling tends to snowball, as falling markets trigger more margin calls, which then cause more selling.

8. Investor sentiment remains at extremely high levels. As I reported earlier in the month, high levels of bullish sentiment correlate to market tops, and extremes of bearishness correlate to market bottoms.

While many market seers see sustained growth and rising stock prices ahead in 2011, investors should look at these eight factors before rushing to join the crowd around the bull's punchbowl.