Don’t Buy at the Top of the Stock Market

The Stock Market is reaching the end of a long rise in values, so heed the yellow caution signs. There are many indications that when the downturn comes, investors who brought their money late to the party will end up taking a financial bath.

It is not time to run, but it is time to put your cash in a safe place.

Our modern Stock Market is not deeply tied to the fate of the real economy; with hedge funds, e-trading, derivatives, and “shorting,” the markets have plenty of things to do with their cash without worrying about messy things like investing, manufacturing, and selling. However, there is one thing that gets everyone’s attention – the candy machine known as QE 3, the U.S. Federal Reserve program that injects $85 billion into the financial markets every month, providing cheap money for banks to use as they please.

The key is to remember that the third round of Quantitative Easing since 2010 (thus QE 3) does not consist of the Fed buying government bonds, which would facilitate deficit spending and stimulate the entire economy. Instead, QE 3 consists of the Fed buying housing bonds from banks and other bundlers of mortgage bonds, thus giving money to these financial firms to spend on stock market purchases, commodity speculation, and maybe a few bank loans. It is the trickle-down theory in a financial management disguise. Give money to the rich and let them do things that will get the economy moving.

In practice QE 3 has two results: (a) mortgage rates are very low, so if you have a good, steady job you can get a cheap mortgage and, (b) financial firms have a lot of money to invest in stocks. Thus, the stock market has steadily risen during QE 3.

So, when Fed Chairman Ben Bernanke told a Congressional Committee on May 22 that the Fed might decide to reduce the number of housing bonds it purchases at one of the “next few meetings” the stock market trembled. Then, the minutes of the April Fed meeting were released later that afternoon and people discovered that “a number” of officials wanted to begin reducing the program in June. Investors panicked. The Dow lost more than 80 points in two hours and other indexes fell, too. With wild rumors about the Fed’s intentions still flying about, the Dow lost 138 points on Wednesday the 29th and 240 points on Friday, May 31st.

These events essentially confirm what many people suspected; the vigorous rise in the stock market since last fall is primarily a function of the Federal Reserves’ stimulation policy. It must be, because the real world economy is in decline:

The Eurozone, the world’s largest economic unit, is trapped in its 7th consecutive quarter of declining growth;
China’s growth is slowing to less than 7% a year (the smallest rate since 1990);
Cuts in federal spending will reduce U.S. economic growth in the second part of the year; and
The gradually falling U.S. unemployment rate is largely a product of 6.5 million people leaving the workforce.

In this environment, stocks will continue to rise only as long as the Federal Reserve keeps pumping $85 billion dollars into the financial markets each month. A major cut-back in that subsidy is likely to lead to a drop of 10% to 20% in stock prices. That means that if you put money in the market when the Dow is at 15,200 and it rises to 15,500 and falls 20%, then it goes back to 13,000 or less and you lose a good chunk of your investment. Wait and buy at the next market bottom, when you see Washington and the Fed stimulating the real economy.

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One response to “Don’t Buy at the Top of the Stock Market

  1. Great post. The market is rigged and functions as a wealth pump, pumping wealth from the bottom to the top, like a walking-beam oil pump (aka nodding donkey, rocking horse), with each stroke analogous to another market cycle. You are right to warn about getting in at the top. People do it every time, and the wealth pump depends on it.

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