While this market looks unstoppable, as central bankers keep pumping out cheap money pumping, the evidence is building that a short-term pullback is likely. We haven’t seen an excursion below the S&P 500’s 200-day moving average since December — and that was the worst decline in the past two years.
The dream-like complacency is settling in. Newsletter writers are more optimistic now than they’ve been since at least 1997. Active investment managers have added to their long positions and are now carrying their largest risk loans in seven years. And regular investors have added a record $41 billion to equity mutual funds and ETFs over the last three weeks. Going back to 2002, that beats the old record by more than 17%.
After October’s rocky finish for the stock market, here are three reasons you should worry about a November correction.
Above all else, the only thing that seems to matter to this market is the flow of monetary policy stimulus from the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan. As long as the money flows, everything else is ignored — from slower earnings growth to unresolved fiscal issues in Washington.
But the thing is, many don’t realize we face the prospect of a much more hawkish Federal Reserve policy making committee in 2014.
Two of the most hawkish regional Fed presidents will be voting FOMC members next year: Philly Fed president Plosser and Dallas Fed president Fisher. Deutsche Bank analysts see an even split between hawks and doves next year; a big swing from where a dovish FOMC is on policy now. Combined with the untested leadership of the next Fed chief, current vice-chair Janet Yellen, and we could see much more dissent and perhaps an earlier-than-expected and more vigorous taper of QE3.
Despite the ongoing preoccupation with monetary policy stimulus, the truth is that the economy is less and less responsive to the treatment. There has been no change to the current QE3 program. And yet the economy is showing signs of stalling.
Bond market derived inflation expectations are rolling over. Crude oil is in freefall. October vehicle sales missed expectations as inventories build. Fourth-quarter GDP is tracking at just 1.7% as the housing market hits an air pocket.
The Markit U.S. Manufacturing PMI is rolling over noticeably, as shown above, falling to lows seen during the 2012 growth scare that prompted the state of QE3 in the first place. So by that metric, QE3 has been a failure.
From a technical perspective, there is a lot to worry about. Market breadth is declining as the selling pressure increases and increasingly fewer stocks hold the market aloft. The Dow Jones Industrial Average is struggling with a massive resistance zone between 15,500 and 15,700. You can see this in the way the McClellan Oscillator, which measures breadth momentum, is rolling over in a way that accompanied recent market pullbacks.
Emerging market stocks are also looking quite weak, which is worrisome since the group tends to be the first mover of any major market trend.
The iShares Emerging Markets (EEM) has already lost its 20-day moving average after sliding sideways in September and October. In response, I’ve added the ProShares UltraShort Emerging Markets (EEV) to my Edge Letter Sample Portfolio.
Overall, I’m recommending that clients book profits, raise some cash, and adopt a more cautious positioning until these warning signs clear.
Disclosure: Anthony has recommended EEV to his clients.