After a roaring 2013, the market has had a rougher start to 2014, flipping between bull and bear modes.
But now that we are in another downdraft for stocks, can we hope for a snap-back … or should investors be worried that we’ve indeed seen a market top and that a deeper correction is in the works?
Unfortunately, there are a host of indicators out there that hint at more pain coming our way.
Now, this is no guarantee that stocks will crash and burn; we’ve had plenty of head fakes since 2009, and the market has managed to march steadily higher in the face of seemingly dark outlooks. Also, a dip of 10% to 15% does not portend the end of the world — and a number of strong players might even manage to swim upstream during broad market declines.
Still, investors should take note of the troubling signs on the horizon. Here are five indicators of a market top and additional declines to watch:
30% Up Years Are a Market Top
Now, I’ll admit that Roberts is pretty loose with his definition of a “bear market” … after the 34% gain for stocks in 1995, for instance, equities still enjoyed another four years of positive returns, even if they were stepping down steadily. I don’t know about you, but if we finish up 20% in 2014 as a follow-up to a big year — which, by the way, was the total return for the S&P 500 in 1996 after that 34% up year — I’ll be pretty darned happy.
Still, the important thing to notice here is the direction of the chart — and most importantly, the depth and duration of the market’s steady decline.
Just because you have time to prepare for a repeat of that market move doesn’t mean you should ignore the possibility.
Margin Debt Shows Troubling Borrowing Trends
Margin debt is defined by Investopedia as “The dollar value of securities purchased on margin within an account. Margin debt carries an interest rate, and the amount of margin debt will change daily as the value of the underlying securities changes.”
This isn’t a big deal if stocks keep going up, because if you borrow $1,000 to buy shares in a stock that gains 30% (like many did last year), you can easily cover your borrowing costs and trading fees.
But when the market turns? Well, that’s when the dreaded “margin call” comes in to play — where investors are forced to sell a stock simply to cover their debts.
This is bad on two fronts: It creates big selling pressure for the market, and also can create cash crunches for investors and financial institutions that cause pain in other areas of the economy.
In short, record margin debt is a dangerous thing for stocks right now.
No Room for Error in U.S. Households
According to their study, “Almost 40% of individuals in the United States either could not or probably could not come up with even $2,000 if an unexpected need arose.”
They go on to correlate the lack of access to emergency funds with the likelihood that a household is overly burdened by debts… but frankly, the causes are academic in the short term.
Because if the stock market takes a modest hit, consumer sentiment declines and/or businesses decide to lay off workers, then there is going to be a very big ripple effect across the U.S. economy.
We talk a lot about the state of the American recovery, but this chart shows in plain terms how fragile U.S. consumers really are.
Sentiment Is Slumping
Click to Enlarge The closely watched American Association of Individual Investors sentiment survey had been firmly in bullish territory for 2013, but has rolled over in a big way this year.
Here’s the rundown from AAII:
“Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 6.9 percentage points to 28.5%. This is the lowest level of optimism registered by our survey since February 6, 2014 (27.9%). It is also the fourth consecutive week with bullish sentiment below its historical average of 39.0%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 0.4 percentage points to 37.4%. Neutral sentiment is now above its historical average of 30.5% for the 14th consecutive week. This is the longest such streak since 1999 (15 weeks).
Bearish sentiment, expectations that stock prices will fall over the next six months, spiked 7.3 percentage points to 34.1%. This is the largest amount of pessimism since February 6, 2014 (36.4%). It also ends a streak of eight consecutive weeks with bearish sentiment below its historical average of 30.5%.”
Long story short: Fewer people are bullish, most investors expect a flat market from here and an increasing number of investors are banking on declines.
Black Monday Comparisons
Click to Enlarge Keith Fitz-Gerald, chief investment strategist over at Money Morning, recently crafted this scary chart comparing the current rally to what went on in the 1980s just before Black Monday.
Now, I’ll concede that a lot more goes into a stock market crash than simply the duration of the rally. But considering how closely these charts mirror each other, it would be dangerous to just ignore them.
Furthermore, while there have been bull markets that lasted more than 1,311 days, it is worth noting just how long this current rally has lasted.
Simply betting on a correction because we’re “due” for one obviously isn’t responsible investing. But the flip side is to acknowledge that stocks cannot march steadily higher forever and that 30% annualized returns are impossible to recreate this year without some major improvement in global economic indicators.
In other words, the bull market is painfully long in the tooth … and based on comparisons to 1982, the correction could be pretty severe when it comes.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.