Stocks and Bonds: Where Cash is King

I probably made a fool out of myself on May 22 when I suggested that stocks were probably topping. In any case, I will not know how wrong I was until much later. For now, it is time for an update on what I am seeing in the markets.

S&P Futures

Since my post, things have turned a little scary. The S&P is sitting at about a 3% loss after recovering from losses as big as 6%. Incredible swings are literally shaking money managers out of their convictions. Everybody who says that things are fine is having to think twice. The price chart to the right shows the trading activity on Wednesday the 12th and Thursday the 13th of August when viewed through the S&P Futures window. Yes, despite happening at the end of an already sharp drop, the curve depicts a wild roller coaster between the two days.
It is believed that the large Thursday's rise was strongly supported by the fact that there were many traders closing short positions to collect their profits. To close short positions, which are designed to make money when assets go down, traders need to buy the asset; adding to the upward pressure from others who felt that prices dropped far enough to make them cheap to buy again.
There is also the fact that the Federal Reserve has an announcement scheduled for next week. From reading my post, you would already know that stocks topped during Federal Reserve Chairman Ben Bernanke's testimony to congress. So, everybody will be paying attention to his words attempting to anticipate how much will the Fed continue to distort markets through their monetary intervention.

Boom and Bust Cycle's Reversion to the Mean

Finally, next week will be quadruple expiration week. Also known as Quadruple Witching, options and futures will expire forcing many funds to re-valance their portfolios. This means that there will be a drop in price volatility, which will surely be welcomed by those still shocked by the gyrations of the last two weeks. The insurance needed for portfolio protection comes down in cost during this period. There will also be a natural push higher on asset prices due to portfolio re-balancing; also a welcomed fact.
After the recent drop in prices, the Efficient Markets Theory would suggest that the risk is to the upside. Recall that no market moves in a straight line. All markets tend to push high further than they should, resulting in bubbles. Markets then correct lower than equilibrium, creating crashes. So for now, there is the chance that markets have temporarily pushed too far to the downside.
In general, there are plenty of factors which will probably push market prices higher in the near term. This means that those who feel that the economic strength is not what it seems will take any price increase as an opportunity to raise cash.
While equity and bonds markets do not directly impact our "real" economy, our "real' economy impacts these markets as well as our businesses and our lives in general. To me, asset markets are therefore great indicators of what is happening to the real economy, if not the creator of such changes.
We are now in an economy where the white house is on an business witch-hunt, bonds are vulnerable, housing is sitting on poor foundations, equities are valued by jittery capital and where there is no fundamental full-time employment growth or long term capital investment. Whenever the market decides to price these factors, asset prices will go down, perhaps by quite a bit, thus making cash the king of the market.