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Tags: signs | naughty | stock market | invest

5 Signs of a 'Naughty' Market

5 Signs of a 'Naughty' Market

Lance Roberts By Friday, 11 December 2015 06:59 AM EST Current | Bio | Archive

While I do suspect that the markets will likely end positively by year-end, it is 2016-2017 that is becomes more worrisome.

From a statistical standpoint, the odds of both a recessionary environment and negative market returns rise substantially over the next two years.

2016 has the lowest average positive return of all years, with 2017 posting the most negative average rate of return.

However, both 2016 and 2017 have posted negative return years more than 40% of the time. Considering that most negative return years coincide with a recessionary environment, 2017 is tied for the second most recessions of the 10-year cycle.

OK, you can breathe easy, right? Statistics say no recession likely until 2017.

There are plenty of reasons that that the market could lapse into a far bigger correction sooner than the historical evidence would otherwise suggest.  Such an event would not be the first time that an “anomaly” in the data has occurred.

The inherent problem with most analysis is that it assumes everything remains status quo. 

The reality is that some unexpected exogenous shock is likely to come along that causes a more severe reversion as current extensions become more extreme.

The following 5 reasons suggest a rather substantial possibility that something could “break” within the markets sooner, rather than later.

  • World GDP Is Contracting. According to the IMF’s most recent report, world gross domestic product contracted by 4.9% in 2015. The only other time that world GDP has contracted to such a degree was in 1980, starting year of the IMF database, when it fell by 5.9%. The U.S. experienced a recession at that time as well as in 2001 and 2009 which also coincided with global economic declines.  Despite many beliefs to the contrary, the U.S. is not an island that can withstand the drag of a global recession.
  • Junk Bond Warning Rises. Jeffrey Snider at Alhambra Partners made a very important point recently stating: “In other words, as junk bonds have been the leading edge to the domestic end of the “dollar” run, this demands close and ongoing scrutiny in light of a potential escalation.  After all, this is just another indication of how advanced the deterioration has become, when the “usual” carnage and selloff is no longer noteworthy, giving way to only the (possibly) spectacular.”
  • Institutions Are Selling. According to BofA, institutions continue to offload equities to retail clients. This is typical of a late stage market cycle as “smart money”  harvests their gains while telling their “retail clients” to “just buy and hold for the long term.” (Just a question to ponder – “if they don’t buy and hold, why is it good for you?”)
  • International and Emerging Market Divergence. There is currently a belief that the U.S. can remain isolated from the rest of the world.  Given the global interconnectedness of the world today, there is little ability for the U.S. to permanently diverge from the rest of the world. Historically when international and emerging markets have declined, the U.S. has been soon to follow.
  • Combined Monthly Sell Signals. Lost in the day-to-day volatility of market action, is the longer term look at the underlying trend of price action. Much like driving a car at full speed, assuming you don’t crash along the way, the car will continue to “coast” for some distance even after the tank runs dry. The same is true for the market. When investors are “exuberant” about the markets, they can keep prices elevated longer than underlying fundamentals and logic would dictate. However, like a “car running out of gas,” the momentum of the market begins to substantially slow until its inevitable conclusion of the advance. If we look at various measures of price action on a monthly basis, we can clearly see warnings that have only previously existed at major market peaks. While this does not mean the markets will immediately crash, historically it has suggested that investors were much better served by becoming more risk adverse.

Whether or not a recession begins in 2016 or 2017 is largely irrelevant. The reason is that by the time the Bureau of Economic Analysis (BEA) adjusts their data, and the National Bureau of Economic Research declares the start of the recession, it will be far too late react.

What is clear, is that the “risk” of being overly exposed to the market currently far outweighs the potential reward. This is why understanding the difference between “possibilities” and “probabilities” is critically important going forward.

Is it “possible” the markets could advance further over the next 12-24 months.

Absolutely.  However, the “probabilities” are mounting that such will not be the case and the resulting negative outcome to investors’ portfolios will be more than most expect.

However, this is the inherent risk/reward dynamic that all investors face, the difference is whether or not you do something with the information at hand.

In the meantime, Wall Street has some great stocks for you to buy.

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. To read more of his commentary, CLICK HERE NOW.

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While I do suspect that the markets will likely end positively by year-end, it is 2016-2017 that is becomes more worrisome.
signs, naughty, stock market, invest
Friday, 11 December 2015 06:59 AM
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