Why this “Distrusted” Bull Market May be Due for a Pause

You can see the evidence in many of the sentiment indicators I track on a regular basis, including …

 The American Association of Individual Investors (AAII) sentiment survey shows less than 30% are bullish right now…

 Investors yanked three-quarters of a billion dollars out of equity mutual funds last week alone, as part of an ongoing exodus this year…

 Even the Wall Street pros remain skeptical of this bull market. Cash balances among institutional fund managers are near all-time highs!

Add it all up and there’s plenty of pessimism in the stock market now, even though the S&P 500 is up a respectable, if uninspiring, 6% year-to-date.

I’ve been taking the other side of this trade recently.

I guess it’s the natural-born contrarian in me that sees excessive pessimism as a catalyst for further stock market gains. Or, as I’ve said previously, bull markets are born on pessimism … which is pretty widespread right now.

In previous Money and Markets articles, I pointed out why the bull market may just be getting started, after notching new all-time highs following a long and frustrating trading-range.

I also pointed out why the storm clouds of a corporate profit recession may have a silver lining, because earnings estimates are being revised higher, which has historically been a very bullish sign for stocks.

That said, there are several good reasons why you should be cautious right now, and be wary of at least a temporary market correction.

Here are a few things to keep a watchful eye on …

#1 – Valuation: Let me state for the record that valuation measures are NOT good at predicting short-term market direction. But by most measures, stocks aren’t cheap today.

I watch a list of different valuation measures for the S&P 500 and the broader stock market, and right now 8-out-of-10 of these measures look expensive.

The most-overvalued indicator on the list also happens to be one of Warren Buffet’s favorites – stock market capitalization to GDP – which says stock prices are nearly 80% above their long-term average. That’s expensive!

Incidentally, such an extreme reading implies a 0% yearly return for stocks over the next 10 years!

#2 – Seasonality & Election Year: We’ve just entered the weakest time of year for the stock market historically. Stocks have declined 56% of the time in the month of September with an average loss of 1.1% based on data back to 1928.

Plus, markets HATE uncertainty. And policy uncertainty often rises leading up to the November presidential election. This year’s election is particularly interesting, which could lead to much higher uncertainty in the months ahead.

Typically, the stock market’s favorite fear gauge – the CBOE Volatility Index (VIX) – rises above 20, on average just before the November election.

Today VIX is just 12, so there’s plenty of room to rise and when VIX rises stocks fall.

#3 – Market Breadth: As the S&P 500 Index has rallied to new all-time highs in recent months, I have noticed subtle deterioration beneath the market’s surface. Since a picture is worth a thousand words, see for yourself …

The index is shown in the top panel hitting a new high above 2,193 last month. But take a closer look at the middle and lower panels.

The middle shows you the percentage of S&P 500 stocks above their 50-day moving average; a common definition of an up-trending stock. This reading was over 80% just a few months ago, but today only 61% of stocks are in uptrends, and the number has been steadily falling since July!

The lower panel shows the number of S&P 500 stocks making new highs over the past 12 weeks. This number also has been falling steadily, meaning fewer and fewer stocks are making upward progress.

Bottom line: These indicators are nothing to get alarmed about, at least not yet, but they tell me stocks are overbought, overvalued and could be overdue for a pullback. September has historically been unkind for stock investors, and with an election looming in November, we’re likely to see higher volatility over the next several months. So keep your stops tight and stay alert for a market correction, which could be a very good buying opportunity!

The ECB blinks: The European Central Bank met today and downplayed the need for more economic stimulus. No extension to the ECB’s QE bond-buying program was announced, and there were no changes in monetary policy.

Government bonds and stocks declined on the news, while the euro strengthen against the U.S. dollar. Year-to-date, the S&P 500 is up 8.5% in 2016, while the Bloomberg Europe 500 Index has fallen 2.2%.

Oil in short supply: Crude oil futures spiked higher today, gaining over 3.5% this morning, after U.S. crude oil inventories fell by a whopping 14.5 million barrels last week, according to the Energy Information Administration.

That was the largest weekly drop in over 15 years, since January 1999 to be exact. But the shortage could prove temporary since Tropical Storm Hermine disrupted shipping and offshore oil production in the Gulf of Mexico last week.

Culling the herd: Demand for dairy products in the U.S. has risen steadily for nearly 40 years, but American dairy farmers have been limiting the supply of fresh milk by thinning their own herds. That was the accusation in a nationwide class-action lawsuit that was settled this week with dairy farmers getting milked for a $52 million settlement. That’s only “a drop in the bucket for such a big industry” according to Bloomberg.

Good investing,

Mike Burnick

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.