There's no question that the rally we've seen in markets up to this point in the year has been impressive. Through the end of last week, the S&P 500 was up almost 9 percent and we're not even through two full months of 2012!
The rally has been fueled by ultra-accommodative measures taken by the world's central banks along with better than expected economic numbers here in the U.S. and in Europe.
|Mainstream media is helping fuel investor complacency.|
Surprisingly, given the rough year of 2011, I almost sense some complacency in the markets, as evidenced by recent consumer confidence numbers hitting one-year highs, and a Barron's cover calling for Dow 15,000.
Savvy contrarian investors, however, know to look beyond the headlines and past the major averages for clues as to the market's next moves.
And when we look past the impressive performance of the S&P year to date, we can see some leading indicators that warrant a level of concern ...
The first is the Dow Transportation Index. This index tends to rally before the rest of the market turns up, and it falls before a general market decline.
The reason for this is quite logical: The Dow Transports, as they are known on the Street, is made up of companies like Fed Ex, UPS, and others that are on the leading edge of the economy. When the economy is growing, their stocks do very well because businesses are shipping goods around the world. And when the economy is contracting, these companies are the first to feel it.
It's a bit concerning then that the Dow Transportation Index did notconfirm the new high we saw in the general market a little over a week ago. This divergence between the two indices has historically been a warning sign that the market may not be as healthy as everyone thinks.
The second leading indicator is the small cap sector. The Russell 2000 has also shown some relative weakness here, stalling while the larger cap indices like the Dow and S&P have made new highs. You can easily see the divergence in the chart below.
Small cap companies, like the transportation sector, are very economically sensitive. And they can fall, or pause first, before the rest of the market heads south.
Professional traders often look at the "internals" of a market, not just the bigger averages, for clues into the future direction. And these two internal indicators are throwing up a caution flag.
But just because the market seems poised to take a header doesn't mean you have to sit on the sidelines and watch the life getting sucked out of your portfolio ...
Inverse ETFs with exposure to these leading sectors of the economy, such as the ProShares Ultra Short Russell 2000 Growth ETF (SKK), can be a good hedge to existing long positions you may have. Or you could consider them as investments to profit from a correction.
Another idea is investments that are out of favor, or that the crowd hasn't caught wind of yet.
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Current Headlines - Finance
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By Suzanne Barlyn CHICAGO (Reuters) - The type of alleged market manipulation by the British trader accused of helping provoke the "flash crash" in 2010 is hard to detect, the chief of the Financial Industry Regulatory Authority said on Friday. Nonetheless, the alleged abuses were "somewhat surprising" given that his behavior was identified in 2009 but continued for another five years, said Richard Ketchum, chairman and chief executive of FINRA, a self-funded regulator for Wall Street. "I won't second guess what happened at the MERC without understanding the facts themselves," said Ketchum, referring to the Chicago Mercantile Exchange, the market that Navinder Singh Sarao has been accused of manipulating from his home outside London.
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Insight - Flash crash charges garner increasing skepticism in high-speed world
By Douwe Miedema WASHINGTON (Reuters) - The notion that one man trading from his parents' house in a working class London suburb had a material role in the 2010 Wall Street flash crash has aroused increasing skepticism from investors and traders since charges were brought on Tuesday. The U.S. has asked UK authorities to hand over Navinder Singh Sarao, 36, after his arrest this week on charges that he manipulated markets over several years in a fraudulent scheme that helped cause the stock market rout. The U.S. Department of Justice alleges that Sarao used souped-up, off-the-shelf software to trick other market participants into thinking massive sell orders were about to hit, causing the so-called E-mini S&P futures prices to drop so he could buy at cheaper levels. The charges against Sarao, operating far from the centre of U.S. markets and engaging in activity some believe occurs every day among larger firms, show that regulators may not shy away from publicity, even if their case may be legally solid. Linking Sarao to the flash crash "smacks of sensationalism," said Manoj Narang, founder of Tradeworx, a firm that supplies data for regulators.
Flash crash charges garner increasing skepticism in high-speed world
The U.S. has asked UK authorities to hand over Navinder Singh Sarao, 36, after his arrest this week on charges that he manipulated markets over several years in a fraudulent scheme that helped cause the stock market rout. The U.S. Department of Justice alleges that Sarao used souped-up, off-the-shelf software to trick other market participants into thinking massive sell orders were about to hit, causing the so-called E-mini S&P futures prices to drop so he could buy at cheaper levels. Linking Sarao to the flash crash "smacks of sensationalism," said Manoj Narang, founder of Tradeworx, a firm that supplies data for regulators. So far, at least 194 people have signed up to an online message saying "One man with a single broadband connection cannot bring down an entire market." Sarao, who court documents show pushed around millions of dollars between banks in the Caribbean, Switzerland and the Middle East, has been granted bail in London on conditions including a 5 million-pound ($7.5 million) bond. His lawyer, Joel Smith, declined to comment on whether Sarao had yet raised the bail and been released, but said he opposes extradition to the United States. CANCEL IF CLOSE The view held by some in the market that Sarao is a scapegoat for the flash crash may not help his case much.