After bullish ’13, does bear loom? Check signs
One of the hardest things about investing in the stock market — maybe the hardest thing — is the timing part. Nobody rings a bell, sends an e-mail or otherwise alerts you when the market is ready to roll over. By the time you figure it out, your portfolio could be down 20 percent or more.
Hence it can be smart to evaluate typical market warning signs every now and then to see whether any are flashing red at the moment. After a sharply higher 2013, a reality check is in order, especially after a few bumpy weeks to start 2014. Here’s a look at some key
indicators.
» The economy. Major stock-market retreats often coincide with recessions. That was certainly true of the most recent bear plunge that ran from 2007 into early 2009, not to mention the mother of all market collapses, which corresponded with the onset of the Great Depression in the 1930s.
Right now, the economy isn’t exactly humming, but it doesn’t seem in any imminent danger of faltering. The most recent gross domestic product reading, for the fourth quarter, showed growth at a healthy 3.2 percent clip after a 4.1 percent rise in the third quarter. BMO Capital Markets expects 2.9 percent economic growth this year, which would be the best pace since 2005. Risk reading: Neutral/low.
» Valuations. Investors routinely look at measures such as price/earnings and price/sales ratios and dividend yields to get a feel for whether stocks are expensive. Market watchers have many decades worth of data to work with. Yet the various value measures don’t always align, and investors often read them differently. Now seems to be one of those times.
Jeremy Kisner of SureVest Wealth Management in Phoenix feels market P/E numbers are in line with historical norms — not low but not high, either. But Allan Flader of RBC Wealth Management in Phoenix thinks many valuation measures are high, including an alternative P/E measure compiled by Yale University economics professor Robert Shiller and a comparison of the stock market’s overall value or capitalization to GDP. He is cautious, largely due to what he considers high valuations. Risk reading: Neutral/high.
» Investor enthusiasm. Some market observers feel the public tends to react in the wrong ways at the wrong times, getting overly excited about stocks when prices are too high or becoming despondent near market lows. Cash inflows into stock mutual funds are one way to measure enthusiasm. They have been rising, and that could be worrisome. Flader points out that the use of borrowing or “margin” to buy stocks is lofty — another bad sign.
But are more people viewing themselves as stock-market experts or exhibiting other signs of overconfidence or exuberance? “Definitely not,” said Kisner. “If anything, nobody seems to know what to do.”
Bank of America/Merrill Lynch compiles a marketsentiment indicator that includes equity cash flows and five other measures. It had moved toward high readings late last year but has dropped back into neutral territory. Risk reading: Low.
» Change in the air. Investors often look for something fundamentally different to justify high or lower stock prices. For example, the efficiencies and cost savings made possible by the Internet was a theme that helped fuel the market’s strong rise in the 1990s.
Is there something different this time around? Flader and Kisner both point to the unprecedented efforts by the Federal Reserve to stimulate the economy as a concern. Many consumers also are struggling.
“There’s a lot of debt out there,” Flader said. “Eventually, there has to be some pain.”
As another negative, Flader points to sluggish job growth and what he feels is an unusual imbalance in the employment market, characterized by millions of people who can’t find jobs at the same time that employers can’t locate suitable candidates to fill open positions.
On the other hand, one thing Kisner and Flader both see as favorable — and not yet fully appreciated — is the nation’s energy revival, with more domestic production of oil and natural gas and decreased reliance on foreign sources. Oil embargoes and spiking gasoline prices — topics that generated so many scary headlines in past decades — have faded into the background. This change could be huge. Risk reading: Neutral.
» Odds and ends. There’s no shortage of other things that investors watch to assess market tops and bottoms. Among these are volatility readings, interest rates and the behavior of other assets. Nicolas Colas, chief market strategist at ConvergEx Group, a brokerage in New York, notes that volatility has been rising but from low levels. This factor isn’t yet signaling a market turning point, in his view.
Nor have interest rates shot up enough to choke off the economic recovery. In fact, rates have eased in recent months after pushing higher early last year, and inflation remains low.
As for other assets, investors often get aggressive near market tops and venture into areas like emerging stock markets. But that’s not happening now, with most markets in Asia, Latin America and Eastern Europe lagging the U.S. and money flowing out of them. “Emerging markets dramatically underperformed last year after underperforming the year before,” said Kisner. Risk reading: Low.
Add it all up, and the stock market’s stumble of a couple of weeks ago looks more like a bruised knee than the onset of gangrene.