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Is the 'euphoria' rally headed straight down the drain?

by Sarah Miloudi on Jan 31, 2013 at 00:01

Is the 'euphoria' rally headed straight down the drain?

Dr Doom Marc Faber has warned equities are 'very overbought' and is getting ready for a February contraction.

His pessimistic call comes as America's Dow Jones and S&P 500 hover around all-time highs, and as a contraction in US growth proved too slight to curb investor enthusiasm.

But sooner rather than later Faber said upbeat investors must accept the rally will come to a halt.  'I am reducing positions because there is euphoria building up,' he told CNBC, adding corporate profits are likely to disappoint and geographical and political problems have not disappeared.

Although many will be used to Faber's downbeat views, the respected economist is not alone in fearing equities in for a pause.  Chartists poring over the S&P 500's latest moves argue stocks leapt past a key threshold last Thursday when they closed at 1,502, its first move above 1,500 in around six years.

In isolation, markets above 1,500 is not a cause for concern, but it is the third time since 2000 this high has been tested and each time stocks were quick to retreat.

Like many, Capital Economics balked at the reaction of a tiny minority that yesterday's 0.1% decline in US growth was the sign of a new recession, but warned risk assets could easily come off even if they fared relatively well through to the summer.

'After climbing to 1,550 by the end of Q2, we forecast the S&P 500 [will] drop back to 1,500 by the end of 2013,' Capital's Paul Ashworth said. 

More broadly, the consultancy believes US growth  will be weak in the first quarter as the payroll tax cut expires.  This could perhaps provide the trigger for Faber's contraction.

Growth could feasibly accelerate afterwards once a deal is struck among policy makers, calming investors and freeing stocks to resume their rise.

Agreeing, Faber said he would not be surprised if a scenario like 1987 emerged; stocks shot up that year 41% over the six months to August, only to shed 40% afterwards.  Although he does not see an extreme decline, Faber expects a more mild, near-term contraction before equities climb again.

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