Stock Market Investors Should Heed These 10 Warning Signs (+2K Views)

Lorimer Wilson January 12, 2015 Comments Off on Stock Market Investors Should Heed These 10 Warning Signs (+2K Views) 2,442 Views

The warning signs are not all flashing red just yet but investors would do well to head these 10 signs that suggest that the markets may drop further and prepare their portfolio before the crowd flocks to the exit.

By John Ficenec, Questor Editor, as posted* on telegraph.co.uk under the title Ten warning signs of a market crash in 2015.

1. Vix Fear Gauge

For five years, investor fear of risk has been drugged into somnolence by repeated injections of quantitative easing. The lack of fear has led to a world where price and risk have become estranged. As credit conditions are tightened in the U.S. and China, the law of unintended consequences will hold sway in 2015 as investors wake up. The Vix, the so-called “fear index” that measures volatility, spiked to 18.4 on Friday, above the average of 14.5 recorded last year.

2. Rising U.S. Treasury Yields

With the Federal Reserve poised to raise interest rates for the first time in almost a decade, and the latest QE3 bond-buying programme ending in October last year, credit markets are expecting a poor year for U.S. Treasuries. The yield on two-year U.S. Treasuries has more than doubled from 0.31pc to 0.74pc since October.

3. Credit Insurance

Along with the increased U.S. Treasury yields, the cost of insuring against corporate credits going bad is also going up. The cost of insuring investment grade U.S. corporate credit against default has become 20pc more expensive, rising from lows of 55 to 66 since July, according to Markit.

4. Rising U.S. Credit Risk

The wider credit market is also flashing warning signs. The TED spread, as reported by Bloomberg, is the difference between the rate U.S. banks are willing to lend to each other and the Federal Reserve rate, which is seen as risk free. The TED spread is taken as the perceived credit risk in the general economy, and increased 9pc in December to its highest level since the end of 2013.

5. Rising U.K. Bank Risk

In the U.K., a key measure of risk in the London banking sector is the difference between the London interbank offered rate (Libor) and the overnight indexed swap (OIS) rate, also called the Libor-OIS spread. This shows the difference between the rate at which London banks are willing to lend to each other and the Federal Reserve rate which is seen as risk free. On Friday, the Libor-OIS spread reached its highest level since October 2012.

6. Interest Rate Shock

Interest rates have been held at emergency lows in the U.K. and U.S. for around five years. The U.S. is expected to move first, with rates starting to rise from the current 0-0.25pc around the middle of the year. Investors have already starting buying dollars in anticipation of a strengthening U.S. currency, with the pound falling 10pc against the dollar since July to hit 1.538 on Friday. U.K. interest rate rises are expected by the end of the year.

7. Bull Market Third Longest On Record

The U.K. stock market is in its 70th month of a bull market, which began in March 2009. There are only two other occasions in history when the market has risen for longer. One is the period leading up to the great crash in 1929 and the other before the bursting of the dotcom bubble in the early 2000s.

U.K. markets have been a beneficiary of the huge balance sheet expansion in the U.S.. U.S. monetary base, a measure of notes and coins in circulation plus reserves held at the central bank, has more than quadrupled from around $800m to more than $4 trillion since 2008. The stock market has been a direct beneficiary of this money and will struggle now that QE3 has ended.

8. Overvalued U.S. Market

In the U.S., Professor Robert Shiller’s cyclically adjusted price earnings ratio – or Shiller CAPE – for the S&P 500 is currently at 27.2, some 64pc above the historic average of 16.6. On only three occasions since 1882 has it been higher – in 1929, 2000 and 2007.

9. Commodity Collapse

Commodity markets have been the lead indicators for a global slowdown, as the prices for oil and iron ore more than halved in value last year. The Bloomberg Global Commodity index, which tracks the prices of 22 commodity prices around the world, fell to fresh five-year lows on Friday at 104.17.

10. Professional Investors Exit

Professional investors are already making for the exit. The Bloomberg smart money flow index tracks the market movements at the end of the trading day on the Dow Jones, when professional investors tend to make their move. The index showed heavy buying activity from 2009 onwards as professional investors followed central banks’ money into the markets, achieving record gains during the past five years. That trend was reversed from the beginning of 2014 and the smart money is now making for the exit, as the S&P 500 carries on rising to new record highs.

Conclusion

The structure of global capital markets is such that the $68 trillion equity market is riskier and sits on top of a credit market worth more than $100 trillion. As yields have fallen in the credit markets, the excess profits have flowed up to equity, in turn lifting stock markets to record highs. The reversal of that trend, one of increased risk and rising credit yields will reduce returns to equity and send shock waves through stock markets.

The warning signs are not all flashing red just yet but investors would do well to head these indicators that suggest caution and prepare their portfolio before the crowd flocks to the exit.

[The above article is presented by Lorimer Wilson, editor of www.munKNEE.com and www.FinancialArticleSummariesToday.com and the FREE Market Intelligence Report newsletter (sample here – register here) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. This paragraph must be included in any article re-posting to avoid copyright infringement.]

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