It has been one of the most staggering stock market rallies in the history of Wall Street. Coming out of the ashes of the market meltdown, which was a byproduct of the mortgage-related disaster that began over 10 years ago, and culminating with a plunge into the abyss of massive selling in March of 2009.
The S&P 500 hit a stunning intra-day low of a rather chilling 666 on Friday afternoon March 6, 2009, and ever since then it has been on one of the most spectacular runs ever. While there were some notable pullbacks along the way, the most significant in the fall of 2011 and to start the year in 2016, for the most part it has been a nonstop moonshot, one that look like it could be close to the end.
Needless to say, along the way there have been a plethora of naysayers, as there always are, but increasingly the data and the market response are looking more and more like a solid correction could be headed our way, which to be frank may be a very good thing. Multiples for almost all sectors are sitting at all-time highs. Here are just a few of the many swords of Damocles that are hanging over the stock market currently. These were noted in a recent research report from Jefferies.
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1. This is the first 12-month period in the history of the S&P 500 without a 3% drawdown. (Source: Bespoke)
2. The CBOE Volatility Index is also the lowest on record, using a rolling 12-month average. The VIX is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange. (Source: Bespoke)
3. At Last Friday’s close, the S&P 500 was down 0.46% from an all-time high. That was enough to drive the VIX up to a two-month high. It has jumped again this week.
4) The CBOE put/call ratio has reached its highest daily reading since March 2017. (Source: @McClellanOsc)
Jefferies isn’t the only firm on Wall Street that sees some treacherous waters ahead for the market. Michael Hartnett, the outstanding chief investment strategist at Merrill Lynch was also just out with a new report that cited some of the froth in the market, especially in the FAANG stocks, which include Facebook, Amazon.com, Apple, Netflix and Alphabet (Google).
Hartnett also noted other specifics that are furthering the Merrill Lynch view that we could be in for a serious correction this winter following some sort of tax reform package agreed upon by Congress. That in of itself could be a long-shot in the view of many on Wall Street.
Citing data from surveys of fund managers, or what is known in the industry as FMS, the Merrill Lynch report shows evidence that there are crowded trades, and a consensus of opinion that may be the kind of herd mentality that can lead to a steep sell-off. Here are just a few of the examples from the report.
1. All-time high “Goldilocks” expectations (not too hot, not too cold, just right), wherein 56% of those surveyed see high growth with low inflation.
2. Bearish viewpoints of secular stagnation are dropping dramatically.
3. FMS cash levels are at just 4.4%, down from 4.7%, which is the lowest since October of 2013.
4. FMS hedge fund exposure is at an 11-year high.
5. Numerous “crowded” trades: Long the Nasdaq, short volatility, long credit.
6. FMS data shows the highest global equity overweighting since April of 2015. That includes the highest Japan overweight position in years. This is in tow with a huge underweight in United Kingdom assets.
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Hartnett did note in his report that the Merrill Lynch Bull & Bear Indicator is up to 7.2, and it has not triggered a sell signal, at least not yet. He also notes that the tax reform package, which many on Wall Street are very positive on, but could be a difficult piece of legislation to agree on, is seen as a huge positive, which could sustain or even inflate the Goldilocks scenario, hence his post-tax reform risk asset correction scenario.
The bottom line is what most long-time investors already know, and it doesn’t take a Wall Street strategist to tell them: The good times don’t last forever, and something has got to give at some point. What triggers the selling is always the million-dollar question, as it could be anything from wage inflation cutting into corporate profits, to a shooting war that breaks out in some hot-spot around the globe, which currently there are many.
While the kind of irrational exuberance seen near the end of the 1990s doesn’t seem prevalent now, as many of the top companies, including the FAANG components, are making money and posting giant revenues. However, many of the solid earnings are being squeezed out by companies that are buying back record amounts of their own shares. When that merry-go-round stops, so may the gains in earnings, which ultimately is the only thing that can push share prices higher.
What should investors do now to protect their gains after such a fantastic run? Here are a few good ideas.
1. Start to take some profits and build up cash holdings to at least 10%. In other words, have some dry powder. Big corrections also can offer big opportunity, especially when we have an economy that could be poised to grow at 3% of higher for the first time in a decade.
2. Hold some sort of hedge in a portfolio. Own some gold and precious metals, for example. Or find a way to own volatility, as it remains close to generational lows now.
3. Shift from momentum growth stocks to value plays. While not as exciting, they may offer better positioning if the market goes south.
4. Clear any and all margin debt now. Margin calls often feed a sell-off like dryness and drought feed forest fires.
5. Sell government Treasury holdings. The long-running bond rally faces upward pressure in rates as the Federal Reserve will lift rates in December and probably three times in 2018.
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Lastly, don’t get lured into the current craze of owning bitcoin. Bitcoin is a digital asset designed to work as a currency. It is commonly referred to with terms like digital currency, digital cash, virtual currency, electronic currency or cryptocurrency.
Bitcoin has exploded in value, and that could be the ultimate harbinger of a serious correction. While it may indeed be the wave of the future, the parabolic rise in price is a warning sign for all investors now.
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