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The U.S. equity markets have lately been testing uncharted territories, with two out of three major indices scaling record highs amid questionable fundamentals. Both S&P 500 and Dow Jones closed at new lifetime highs last Monday.

In the face of a mixed bag of economic news, and continued uncertainty in overseas markets, Bullish traders remain at the helm in shaping the market’s path. However, on the other side of this investor optimism lie traders and technicians who are increasingly concerned with what the charts and economic indicators point to. (Read: Market Crash in the Cards? 3 Stocks to Book Profits)

General Electric Company (GE - Analyst Report) saw a spurt in trading volumes, climbing over 3.3% in less than a week to $27.53 on June 9, and is currently trading close to its 52-week high. While technical analysts are applauding the sluggish giant’s sudden momentum and taking it as a sign of renewed market vigor, history begs to differ.

Before discussing the significance of General Electric’s rally and what it indicates, let us see what the broader indexes reflect.    

Weak Technicals

The S&P 500 has drafted its recent uptrend on extremely low (and decreasing) volume in a backdrop of persistently low volatility. According to Bloomberg data, average daily volumes for the S&P 500 slipped to 1.8 billion shares last month, the lowest since 2007, compared to 2.7 billion in 2012. Surging stocks amid weakening breadth and volumes is a warning sign that has preceded losses in the past.

Further, the rise should be supported by an increasing number of stocks hitting new 52-week highs. Presently, the number of NYSE components touching new 52-week highs has been steadily trending lower, indicating lesser stock participation in the recent Bull Run. A similar divergence pattern of 52-week highs among broader stocks and the S&P 500 was seen in the run-up to the 2000 and 2007 peaks.
                                                                                         
The surge in General Electric was accompanied by other industrial conglomerates such as Tyco International Ltd. (TYC - Analyst Report), 3M Company (MMM - Analyst Report) and Honeywell International Inc. (HON - Analyst Report), all of which touched new 52-week highs on June 9.

What Does GE’s Rally Indicate?

In recent times, whenever investors have come around to bidding up General Electric shares, it has generally been followed by the culmination of a broad market rally with some kind of pull-back or consolidation. It happened once in the end of 2013, when General Electric’s shares suddenly increased 5.6% on high volumes between Dec 12 and Dec 31, eclipsing the 3.8% increase in S&P 500. What followed was a quick five-week sell-off chopping 6% off the index, while General Electric tanked 13%.

Similar instances were witnessed in 2012 spring and autumn as shown in the chart below. While history does not really predict the future, the conglomerate certainly displays a flair for abrupt strong upward momentum just when the broader markets show signs of exhaustion.

Fundamental Attributes

The nation’s economic output, measured by Gross domestic Product (GDP), contracted 1% in the first quarter of the year, reflecting the worst performance in over three years and deferring hopes for a sustained growth pickup. Weak core retail sales coupled with stagnant wages and higher-than-expected unemployment claims seem to have left the U.S. economy susceptible to macro headwinds.

Additionally, the last earnings season depicted feeble growth, with most companies providing negative guidance – a recurring theme for over a year now. However, disregarding the temporary effects of an unusually harsh winter, some analysts are confident of growth bouncing back in the second quarter, pointing towards strong consumer spending even in the backdrop of a contracting economy.

The Investment Community

Building up on the fragile technicals is the skepticism in the investment community. Reflecting widespread risk aversion, global money managers raised cash holdings to a two-year high in May, per a recent survey conducted by Bank of America Merrill Lynch, the investment banking division of Bank of America Corporation (BAC - Analyst Report).

Another survey of 530 professional money managers, conducted by the CFA society of U.K., offers an insight into the views of the community that manages billions of pounds on behalf of pension funds and households. The findings reveal that the number of investors who believe that S&P 500 and FTSE 100 are overvalued has reached its highest level at 49% compared with 39% just a quarter ago. Only 16% of the respondents believed that there were further gains to be made in the stock markets, significantly down from 50% at the beginning of last year.

To Conclude       

While the long-term expectations seem to have bullish overtones, the present loss in momentum has hurt the market foundations. While forecasting an immediate market crash might be stretching it a bit, investors should be cautious of an imminent sell-off. The markets look set to take a breather from the prolonged rally, so let the economic and corporate fundamentals catch up.

 

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