10 Warning Signs of A Dangerous Stock Market
While many investors may be breathing a sigh of relief thanks to the bounce off the February low, with the S&P up 11% since the start of February – it’s still not all lollipops and rainbows out there in market-land. There’s some worrying undercurrents that could spell more trouble ahead, not to mention pros like Jeff Gundlach claiming there’s just 2% of upside in the S&P 500 and 20% downside.
Just what’s on the mind of some of the sharpest investment managers out there? We were lucky enough to have Mike Melissinos of Melissinos Trading send along a collection of charts and indicators he’s been looking at with a worried eye, and thought it was worth sharing here. Enjoy…
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I’m sure a lot of you have noticed the weakness in the stock market lately. If you’re wondering whether this is a short-term dip within the bull market or the start of a larger bear market, I’d like to provide you with some information that may help you decide. See the charts on the following pages.
I do not use any of the charts or information below to make investment decisions. I base all of my trade decisions on the price trends of the markets within my portfolio.
I understand that not everyone employs this price-only style, but instead prefer to base decisions off of fundamentals. They believe the fundamentals give them a better idea of the stock market’s health. The charts below mostly fall into the “fundamentals” category, so for you fundamental guys and gals, these charts may help you.
For the record: my firm holds short positions in several stock markets including the S&P 500, NASDAQ 100, Hang Seng (Hong Kong), IBEX 35 (Spain) and MSCI Emerging Markets Index.
Dangerous Stock Market – Decline in Profit Margins
When margins shrink, business activity contracts. Businesses cut budgets and jobs. Recessions typically follow. Stock prices tend to fall more than 10% in recessions.
Price-to-Sales – Expensive
The Industrials sector provides some insight into the health of U.S. manufacturing.
At October-end, the sector recorded one of the highest P/S ratios ever. Only the two-year window of the dot-com bubble produced higher readings.
Industrial Production is Rolling Over
The most recent Chicago PMI reading of 42.9 has never been this low outside of a recession.
YSE Margin Debt at Record Levels
Investors have borrowed capital at a record clip to buy stocks. Since 2009, investors have gone all in and then some.
Margin Debt has spent the last few months beneath the 12-month moving average. In the past 20 years, this indicator serves as a decent bear market signal.
Margin Debt to GDP – Higher than 2000 and 2007
As a percentage of GDP, margin debt hit a record high in 2015. The Fed played a massive role in this – allowing investors to borrow tons of money to buy stocks. But that’s another conversation for another day.
Some people think the Fed will ab
andon its plans to tighten and begin lowering rates again, or to adopt NIRP (No Interest Rate Policy). If so, the belief is that the bull market will continue.
Margin Debt-to-GDP and 3-Year Stock Returns
When speculation runs wild, future returns typically suffer. Today, we have wild speculation – a general belief that the bull market will continue because (insert your reasons here).
During the heydays of the dot-com and housing bubbles, margin debt-to-GDP levels were the same as today. If given a reason to a sell, over-extended investors may begin selling more intensely.
How Much Stock Do People Own? The 2nd Highest Amount in History.
How to read this chart: In general, the higher the reading the lower your future returns.
Highest Reading = March 2000. The S&P 500 fell 43.40% over the next three years.
Second Highest Reading = January 2015. The S&P 500 has fallen 7% since (13 months).
Third Highest Reading = September 1968. The S&P 500 fell 1.70% over the next three years.
Investors Sell Dividend Funds, MLPs, REITs and High Yield
In mid-2010, the Fed launched QE2. Investors increasingly ran into assets that provided at least some yield; this being dividend funds, MLPS, REITs and high yield bonds (blue line).
Today, the blue line is rolli
ng over – possibly suggesting that investors are beginning to prefer safer cash accounts and shorter duration bonds. This may add to the selling pressure in stocks.
Bull to Bear Ratio – Unprecedented Optimism
The Bull to Bear Ratio over 3.0 (red lines) may suggest overconfidence and a lack of worry. If so, we have a lot of confident bulls out there.
Dangerous Stock Market
– Turmoil in High Yield Bonds
The “smart money” lives in the bond world. Bond prices have a tendency to move before stocks do – as evidenced by the chart below. Will this time be different than the previous three?
That was a long post, but I think you get the picture. Whether the price trend follows suit is another discussion. No one knows, especially me. But I hope this information helps you develop your own opinion and strategy to handle the ever-changing market conditions.
Dangerous Stock Market
Past Performance is Not Necessarily Indicative of Future Results