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Related topics: stocks, Federal Reserve, shorting, investing strategy, Bill Fleckenstein

For the moment, the massive debts (and associated ramifications) of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) appear to have been essentially forgotten, at least by the U.S. stock market. Similarly, the unrest in the Arab world has been more or less disregarded, except when an event has grabbed headlines in a huge way.

There is no question in my mind that the risks of dangerous outcomes in the short run are quite high for Arab countries, as well as for the European banking system. Yet it does not appear that stock prices in the aggregate have adjusted for that.

As if that weren't enough, we have our own domestic issues: inflation, interest rates that are too low (yet can't be raised), and huge budget deficits. (We'll leave out the worthlessness of our currency for the moment.) Those problems also do not seem to be priced in, and when I put a summation sign under everything, it is easy to see that equity prices have not built in any margin of safety.

Do we need to stay for the credits?

People seem to think that the absence of bad news means all is well, but that is not necessarily the case. Over the last 10 to 15 years, we have seen this denial "movie" many times, and now it is playing once again. But at this particular moment, the easy money from the Federal Reserve -- which has kited stock prices higher over the last six months and helped keep the market aloft for the last two years -- is slated to end pretty soon.

Image: Bill Fleckenstein

Bill Fleckenstein

At the market-action level, however, recently there has been some divergence from past behavior. For example, on March 9, optical fiber company Finisar (FNSR, news) did a 4-for-3 stock split the old-fashioned way (i.e., its stock price declined 25%) on the back of losing at beat-the-number (its quarterly earnings were below analyst estimates and/or company guidance). That, in turn, saw a number of what I call "high-flying" speculative stocks severely punished by the market.

Part of Finisar's problem appeared to be weakness stemming from double ordering by customers in China, which made demand look higher than it actually was. So issues are not entirely company-specific, but on that day, Finisar's results were treated as far more applicable to Wall Street than they probably were, which is a shift in the pattern.

My point in mentioning Finisar is that the market reacted differently. The last couple of times Cisco Systems (CSCO, news) reported, its problems were always treated as company-specific, and thus there was no collateral damage to related companies. Therefore, the small list of "things that are different" regarding market action is building. Further, it is pretty clear that in the last few weeks there has been a slight change in tone, as the extremely expensive/concept stocks have not only lost their place as upside leaders, but actually become the leaders to the downside.

Are we there yet?

It is too early to tell exactly where we are, but the market has just experienced a modest failing rally. However, for my purposes I would not count that as a "trend change" just yet. Still, we might be seeing the very early indications of a top being put in place.

When I have made comments in the past about wanting to see a failing rally before I felt comfortable getting short, I meant something more pronounced -- both in terms of percentage change and time -- than what we have experienced so far.

Whatever damage has been done in the last couple of weeks could be easily undone (at least temporarily) by a single euphoric, two-day rally, something that could erupt simply because the price of oil dropped as the unrest in one Arab country or another temporarily subsided.

Nonetheless, it is time to be extremely cautious about stocks generically, though I have not really favored them throughout this rally, preferring to focus on beneficiaries of federal money-printing. I continue to suspect that short-selling will become profitable at some point in 2011 (as well as less risky) when we get further down the road.

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The biggest problem that equity bulls face is that the single most important factor in catapulting equity prices higher in the last couple of years has been easy money (in the form of QE1 and QE2 from the Federal Reserve), and that is ending in June.

Thus, perversely, for the stock market to see more of the liquidity it craves, it needs to tank first. Liquidity matters as much as it does because the economy itself is not likely to get all that much better relative to expectations. I think it will improve for a while, but I don't think it will grow at the rate the wild-eyed stock bulls are hoping for. Bottom line: The easy money in the stock market has already been made. Now life will be much more difficult.

It's a great time to 'bye' bonds

On a final note (and speaking of being cautious), last week Zero Hedge reported that Bill Gross, who runs the world's largest bond fund for Pimco, has cut his Treasury exposure to zero. For a while now that market has been sinking and has looked like it needed new buyers. Now, apparently, it needs even more, which will be another issue the stock market must deal with.

At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column. He does own gold.

This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.