Major selloff coming?

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Stock markets are seriously overbought right now.  But, the rally in shares has been bolstered by better than expected economic data and earnings reports.  I first pointed to a rally in shares in March, but I didn’t get fully onboard until April (after all, people like Louise Yamada were still pointing to downside risk).

But, by early June, the rally was looking toppy and soon, most savvy investors were saying stick with high quality over junk, despite the huge run up in risky stocks. Personally, I saw June as an important period on the data front, because if data disappointed, shares would sell off. Otherwise the bear market rally could continue, aided by short-covering.

The data in June was better than expected and shares continued to rally despite being seriously overbought.  However, the day of reckoning may be upon us.  Yves Smith has a good post “Is This the Start of the Big One?”up as to why.

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What worries me is that the rally in shares has been pure multiple expansion. You have quality retail stocks like Nordstrom (JWM) trading for 20x forward earnings when there has been no discernible uptick in retail sales.  That’s crazy.  Moreover, as I said in May when consumer confidence was exploding through the roof, “Let’s remember that confidence does not translate into consumption, especially as most of the uptick here was in consumer expectations.” And, indeed, underlying consumer demand has been weak.

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So, where does that leave us? Back to where we were in late May, awaiting another set of data points to confirm the initially bullish economic data of this past summer.  If the data is good, shares will rally yet again.  However, there is increasing concern that the global recovery will not be robust. See this morning’s CNN Money’s article.

With China in full bubble mode and stocks there having sold off over 5% today, we are seeing a major meltdown across Asia and Europe as worries that we have gone too far too fast take hold. Below is the pre-market data as of 8:45AM ET.

pre-market-2009-08-17

As we head into September and October, when many major market crashes have happened, expect investors’ nervousness to increase.

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