Stock Markets Very Vulnerable, Should we be on “Crash Alert”?

Posted by Patrick Ceresna on May 5, 2014 9:36:00 AM

Market conditions are very vulnerable and only need a small catalyst, like a spark needed to idle sitting fuel, to unleash the animal spirits amongst investors. Consider a “Crash Alert” warning to be similar to the “SEVERE” red alert issued by U.S. Homeland Security to warn of a heightened risk level of a terrorist attack. It does not guarantee an attack, nor suggest that conditions could not deescalate to the “ELEVATED” yellow alert in subsequent weeks without incident.  It simply means, pay attention, take precautions and avoid high risk areas.  That is all we can ask of our readers to do the same with their investment accounts.   describe the image

So are we on Crash Alert?  Let's look at our current criteria.  

Criteria for our “Crash Alert”::

  1. A strong and rallying bond market. Interestingly almost every major market correction or crash or bear market in the last 15 years was preceded by rising bonds (lower interest rate trends).  Historically an inverted yield curve would usher in a recession, but with the active manipulation of short-term interest rates by the central banks, we will be robbed of the true and well tested signal.  While we may not get a yield curve inversion, we are clearly seeing a flatting of the yield curve as 30 year treasury bonds are roaring full speed ahead while short-end yields lag.   
    30yTBond May 2014 resized 600 
  2. A deterioration of “Market Breadth”. An old wise trader once told me that markets become bearish long before the price of the indices turn.  That is words of wisdom that have been etched into my brain and is ultimately what drove me to track my own proprietary Breadth Indicator (CMB).  What you can see is that in spite of the Dow Jones and S&P500 at the cusp of all time new highs, the participation of stocks is eroding rapidly.     
    CMB Index May2014 resized 600 
    May2014 Bull%Index SPX 1 resized 600 
    %NYSE Above50day 1 resized 600 
  3. A failure of leadership stocks (particularly financial stocks). Throughout this multi-year bull market advance, much of the leadership can be attributed to the financial and technology (social media) sectors.  The last two months have seen a distinct rotation out of many of those names.  Notable mentions: American Express (March high), JP Morgan (March High), Visa (January High), Goldman Sachs (January High), Citigroup (January High), Bank of America (March High), Facebook (March High), Google (February High), Amazon (January High) and Netflix (March High). Note that the bullish % index on the Financial and Technology Indices are lower than at any point in 2013.  Ouch.
    Bullish%index Financials resized 600 
  4. The markets demonstrating a turn in price action.  This is the only criteria that is still dubious in its interpretation.  The index levels remain near highs and we have yet to see price action deterioration to confirm the market breadth deterioration we discussed above. We are seeing substantial resistance on the Dow Jones and S&P along their all time new highs, but no motivated selling is evident yet.  We remain 132 S&P500 points above the 52 week mean price, which leaves plenty of downside room for a correction.

While only 3 of the 4 criteria is met, we feel that when price action finally turns lower, it will happen very fast leaving many investors and traders feeling like a "deer in headlights". Watch our twitter feed @MTStrategist for current updates as to where we feel the market is at. 

Back at the start of April we published our “Second Quarter Market Forecast” where we extensively compared the current 5 year bull market to the 3 other notable bull markets from over the last 30 years. We concluded that there was an increasing probability of a meaningful market correction within the 2nd Quarter. Though April has not brought about any aggressive selling, we see market conditions considerably worsening and numerous warning flags waving.

Market Breadth:

Ceresna Market Breadth Index: Bearishly Crossed Lower
52 Week Mean Price of S&P500: 1749 (132 points below market)

Volatility Index: 12.91%
(20.72% High Feb 5th)
Number of Stocks Above 50 Day Moving Average: 60.60% 
(surprising low)

Topics: s&p500, Market Crash, Crash Alert

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