Stocks, as represented by the Dow Jones Industrial Average, continues to flirt with new all-time highs. The bulls are watching, wide-eyed, as the index threatens to clear massive technical resistance that goes all the way back to August.
Fresh stimulus measures from the European Central Bank, the “untaper” from the Federal Reserve, and easing of Chinese inter-bank lending conditions, and some better-than-expected economic data has all contributed.
And yet, beneath the surface, there are signs of trouble as bullish sentiment reaches a rare extreme. Here are three reasons to be cautious.
#1: CEOs are bailing out
Click to Enlarge According to research from JPMorgan (JPM) “Flows & Liquidity” analyst Nikolaos Panigirtzoglou, non-financial corporates in the G4 economies have stopped soaking up their own equity in Q2 for the first time since the Lehman Bros. crisis. And based on an analysis of announced share buybacks and leveraged buyouts, the situation worsened further in Q3.
The problem is that free cash flow is drying up, as shown in the chart above.
Not only have purchases slows, but issuances are up with more IPO and secondary offering activity. You don’t have to be an economist to understand the message CEOs are sending as they offer more supply and bid less demand. They think equity prices are topping. At least, in terms of bond prices.
#2: Stocks vs. Bonds
Click to Enlarge Futures from the CFTC shows that speculative investors are the most overweight stocks vs. bonds since 2005.
Jason Goepfert of SentimenTrader notes that the relationship between stock prices and bond prices (stock prices high vs. bond prices low and yields high) has moved so far out of normal that the ratio of the S&P 500 and the 10-Year Treasury yield is three standard deviations from normal.
In layman’s terms, that only happens 0.1% of the time.
So it’s rare.
The only other times that bonds have underperformed stocks to this extent in the last five years was back in May 2013 and in September 2012. Both times were almost immediately followed by stock market declines.
#3: Emerging-Market Stocks
Click to Enlarge EM stocks tend to be the leaders of any new market trend given their sensitivity to changes in the health of the global economy. They are vulnerable to shifts in both trade volume and commodity prices. So they act as an early warning system if all’s not right.
So it’s worth noting that the iShares Emerging Markets (EEM) is in free fall and has already fallen below its 200-day moving average for the first time since May.
Back then, as the EEM fell apart in late May, the Dow didn’t succumb to the selling pressure until late June.
For this reason, I continue to recommend clients look for opportunities on the short side via picks like the UltraShort Emerging Markets (EEV), up 10% since I added it to my Edge Letter Sample Portfolio on November 4. My short against Tesla Motors (TSLA) is up 17% since Oct. 29.
Disclosure: Anthony has recommended EEV long and TSLA short to his clients.