Three Indicators That Proceeded Past Downturns Are Now Flashing Are Signs That Indicate A Stock-Market Tumble Ahead.

http://online.wsj.com/articles/three-signs-that-point-to-a-stock-market-tumble-ahead-1406913915

 

Mark Hulbert's analysis was posted on internet Aug. 1, 2014 1:25 p.m. ET and was printed on page B7 of the Wall Street Journal August 2, 2014.  Over the past 45 years, the stock market has lost more than 20% each time three warning signs of Mark Hulbert flashed simultaneously and all three were flashing August 1, 2014.  The signals are measures of excessive levels of bullishness and enthusiasm; significant stock overvaluation, based price/earnings ratios; and extreme divergences in the performances of different market sectors.

A bear market is considered a selloff of at least 20%.  Hayes Martin’s research as president of Market Extremes, an investment consulting firm in New York finds that the indicators have gone off in unison six times since 1970.  The S&P 500's average subsequent decline on those earlier occasions was 38%, with the smallest drop being 22%. In fact, no bear market has occurred without these three signs flashing at the same time. Once they do, the average length of time to the beginning of a decline is about one month, according to Mr. Martin.

 

The first two of these three market indicators the percentage of advisers who described themselves as bullish rose above 60%, a level Investors Intelligence, an investment service, considers "danger territory." Its latest reading, as of Wednesday, was 56%.

 

The price/earnings ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rose to its highest level since the benchmark was created in 1984—even higher than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

 

The third of Mr. Martin's trio of bearish omens, the fraction of stocks participating in the bull market, declined markedly.   One measure of this waning participation is the percentage of stocks trading above an average of their prices over the previous four weeks. Among stocks listed on the New York Stock Exchange, this proportion fell from 82% at the beginning of July to 50% on the day the S&P 500 hit its all-time high. 

Mr. Martin said it was one of the sharpest breakdowns in market breadth that has ever seen in so short a period of time.  Another sign of diverging market sectors: When the was the S&P 500 hitting its closing high ahead 1.4% for the month on July 24, in contrast to a 3.1% decline for the Russell 2000.

 

Mr. Martin's said stocks with smaller market capitalizations will be the hardest hit and forecasts that the Russell 2000 will fall by as much as 30%.  Among the hardest-hit stocks during a decline will be those with the highest "betas” semiconductors in particular—and technology stocks generally.

 

What to do?  We have already gotten out and have a small amount invested in gold silver stocks.  We anticipate an additional 5% drop within a week or two and a recovery of most of the loss as the FED talks about attempts to calm the markets.   Some stock short term buying opportunities may occur initially. Then an initial FED talked-up recovery may be another opportunity to get completely out of the market. 

 

However, because hedge funds covered so much of their short selling we expect renewed short selling and other dumping of stocks will trigger a classic bear market that will run its course over several months.  And since stocks will be beaten down, corporations will use the next quarterly reports to acknowledge all the hidden losses they have been carrying due to pressure by Jim Cramer type analysts who punish bad news during bull markets and punish fudged profits and revenue in bear markets.  Deceptive optimistic bookkeeping during bear markets are often treated as criminal by irate stock holders and regulators so that bear markets are when the companies will take all possible loses hidden by LIFO vs. FIFO bookkeeping and “creative” accounting.  That is why the stock market is such a good forecaster of the economy.  Bear markets cause belt tightening and a general economic slowdown.  Bull markets generate cash which can be used for growth if there is confidence in national leaders and economic policies.