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1/31/2011

With more and more players jumping into US stocks as if they were a riskless asset…along comes an event that uncovers underlying risk.

Over the past few months it was becoming apparent that more and more traders, investors, speculators...etc, were viewing US stocks as a must own commodity, and with incredible gains posted in the major indexes since last August you’d almost look stupid criticizing them.  However, as we mentioned in our market round-up on Jan 18^th, with scenarios that almost appear riskless because they keep going up…reality is that these markets are laden with massive risk that are susceptible to noteworthy downside moves.

Last Friday was case in point for the major US Stock indexes, as the news of chaotic unrest in Egypt sent jitters throughout the equity markets.  The Egypt event simply revealed the underlying risk of an asset class that is backed by speculative momentum rather than sound fundamental forces.   However, before the bears begin reveling in last week’s down move, the price action needs to be put in perspective and this perspective further highlights the bubble that has been forming in this market.  US Stocks were on such a speculative tear that the major indexes were set to achieve gains of nearly 4% for the month of January alone were it not for Friday’s correction.  Now the indexes are still in the black by over 1% on the month after the sell-off. 

What reveals massive risk in bubble markets are exogenous events that rattle speculative longs…where these events sometimes force markets to return to normal valuations.  Is the Egypt event one of these?  Perhaps, if the chaos spreads to other regions in the middle east or around the globe, but that is a big IF.  However, the bottom line remains that US stocks continue to have substantial underlying risk as current valuations.  Keep your seatbelts fastened.