10 Reasons to be cautious on equity markets

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

Here are my 10 reasons to be cautious on equity markets right now.

Valuations are stretched

Trailing and forward price-to-earnings multiples are now in the top quintiles historically and the most expensive in 15 years.

Only in 1929 and the “Dotcom” bubble has the cyclically-adjusted multiple (CAPE) been as high as the case today.

We are heading into the ninth year in the cycle and have logged an epic 250-per-cent surge in the process. As retail investors now plow in to this market in the late innings, one could legitimately ask what it is they could possibly know that corporate insiders do not, considering the latter have been selling their company’s stock this year at a pace not seen since the data began to be published in 1988.

Extended leverage

U.S. margin debt has surged at a 27-per-cent annual rate since immediately prior to the election to stand at $513-billion, the highest level on record (eclipsing the high from April 2015).

Retail inflows

After an eight-year hiatus ($200-billion of net outflows), private clients have thrown in the towel and plowed nearly $80-billion into mutual funds and ETFs since the November election.

Remember Bob Farrell’s Rule No. 5: “The public buys the most at the top and the least at the bottom”.

Narrowing leadership

For the past four sessions, we have seen more new 52-week lows than new highs (the longest streak since Nov. 4) — a technical sign of a toppy market.

Moreover, the Russell 2000 index is now flat for the year and off 4 per cent from the high — again, we know from history that the generals tend to follow the privates.

Tack on the fact that the S&P 500 recently traded as much as 10 per cent above the 200-day moving average, and we have a market ripe for a near-term correction.

Complacency abounds

From a VIX of 11.9 to nearly 60-per-cent Bulls in the Investors Intelligence poll — though this has begun to roll off its highs in a sign of the “smart money” beginning to take profits.

The S&P 500 has gone 57 days without so much as a 1-per-cent intraday swing, something we have not seen in at least 35 years. The proverbial calm before the storm.

The Fed is in play

The front-end Treasury yields are rising discernibly — the two-year T-note yield has gapped up to nearly 1.4 per cent and futures market is in the process of pricing in an extra two rate hikes after the likely March tightening (the overnight index swaps market currently has priced in 70 basis points of tightening by year end).

The Fed has met its twin objectives and the fed funds rate consistent with that is 3 per cent, not the 0.75 per cent currently.

By the time the Fed reaches that level, the yield curve will likely have inverted long before and that’s when the clouds will come rolling in.

This could be next year’s story, which means a forward-looking market begins to discount this prospect sometime later this year.

Inflation pickup

Cyclical price pressures are showing through, with the core PCE inflation rate at a 30-month high of 1.738 per cent year over year.

As was the case in 1990, 2000 or 2007, this likely is not sustainable, but is a classic late-game signpost nonetheless.

All one needs to see is the latest blow-off in the commodity complex, which is now on pause, to notice how late cycle we are. Remember what oil did, for example, in 2008?

Lofty expectations

The survey data are at extremely high levels at a time when actual economic growth is running barely above a 1% annual rate.

Gaps like this, once again, are classic near-end-of-cycle developments.

The prospect of there being huge disappointment over the pace of policy change in Washington is also very high.


While households were not net buyers of equities until very recently, the near-quadrupling in the stock market has still boosted their exposure to a 21.1-per-cent share of total assets. Only five times in the past 16 years has the share been this high or higher — this is 42% above the norm.

Frothy credit markets

Bonds lead stocks, just know that. And the risk-premium on U.S. high-yield corporate bonds very recently approached lows for the cycle at a super-tight 335 basis points.

However, they now are widening again, and with the overall narrowing path of the Treasury curve, this is well worth monitoring for those equity investors who are still long this market.

Nobody ever lost money by booking a profit, especially for a cycle that is now heading into year number nine.

Do you think that David is right?

Being Canadian, I am worried about the Federal Budget scheduled for March 22 because there are rumours of an increase in the capital gains tax. I have been taking some profits in my taxable accounts and for investment club just in case. I do believe it is impossible to time the market so I am still fully invested in my tax sheltered accounts.


13 thoughts on “10 Reasons to be cautious on equity markets

  1. Ciao Rico,
    I think that some of these points are totally “spot on”, and I believe that more than one investor is a bit “concerned” about a market crash, in the near future. Of course things are not easy to anticipate. On the other side there hasn’t been a momento in history when bonds were so overpriced as they are now, so it’s not sensible for an investor to switch to them now as what they gain in interest is lost in capital depreciation.
    I am looking at ways to hedge my long stock PF, using some shortETFs. If the market tanks by 50% they will be of little use, but better than nothing I’d say! 😛


  2. Ciao Stal, first of all, your English is much better than my Italian cousins. I don’t think that the market will crash in the U.S. unless the Fed is more aggressive in raising interest rates. Most North American money managers are waiting for a 5% to 7% correction to put more money into the market.

    There is an 100% chance that the Fed will raise interest rates next week and everyone will be tuned in to hear that the Fed will say during the press conference.


    • Ciao Rico,
      Thanks 🙂 Well I have to say that after 5 years spent in the UK (and more than 20 traveling the world for business) I always say that my English is much better than my Italian as I had to learn the former, while I was sort of “given” the latter! 🙂
      I do not think it’s just about the Fed, they will try to “soft crash” the economy with incremental rises, what I am concerned about is the state of the economy as a whole, with incredible debts from each country and a general “anti-immigrant” feeling that is sprouting up a bit everywhere. As usual the next crash will be something that nobody will see coming (apart from few individuals that will make enormous profits from it), so I am not stressed about it to be honest, but I can start looking for potential way to hedge risk of a fall.

      On the other side I always like to think that, as I invest in blue chips with a good dividend track record, a crash might happen but if it will make Coca Cola or Siemens or Diageo bankrupt, then the problem is much bigger than just the investment that I have and I guess that the money lost that way will not be the first of my problems…
      Ciao ciao


      Liked by 1 person

      • You seem to own a lot of consumer staple stocks so you could buy some puts on XLP to protect your holdings. Raising interest rates could cause your dividend paying stocks to fall. I am watching the 10 year U.S. bond yield, the 3% level could be bad for dividend stocks.


  3. Ciao Rico,
    I am not familiar with ETF trading, but technically if I buy puts if the price falls and I get ITM it would be a bit like shorting the ETF, right?
    But I am interested in the buying options story, so far I have only shorted my options, I have never been a buyer, and maybe I am missing a good chunk of the story there, as I am sure there are people that can make money buying instead of selling…

    I also agree with you, when the 10y touches 3% there will be some stronger movement out there, and food+staples are going to get targeted. Luckily for me at the moment my average price is lower than actual price so my hope is that the fall is not too sharp and strong, then when price arrives at -10% from my average the rule that I have set in the portfolio is to reassess and eventually DCA on the stock.
    I am in for the dividend so as long as they don’t touch that…


    • Yes buying puts is like shorting but less risky because the max loss is the cost of the put if it expires worthless. However, put premiums are really cheap right now. Selling short term covered calls is another way to protect your positions.

      I am hoping that a small correction so that I can increase my holdings of good dividend paying stocks.


      • CCs are good because they get worthless if the market crash, right? Take the premium and “go away”. This is a strategy that I am already working with, I have never seen if as a way to protect my positions though… I think that buying puts is something that I need to research more, especially on how to manage them, because I have never had to work with them… For what I can see these are the possible scenarios:
        1. If I buy a put and the stock doesn’t fall, premium is gone and put ends OTM wothless.
        2. If I buy a put and stock falls, but the put is ATM in that case it might make sense to sell it back (and possibly profit from it).
        3. If I buy a put and stock falls, put now ITM, selling it before the day of expiration will incur in profit.

        What happens if I let a bought put expire ITM? Do i get assigned the stock?

        The good point of selling puts is that I do not have to do anything if the trade goes well and I am happy to take them to expiration…


      • If you buy a put on a stock that you own and the put is ITM then you can sell it for a profit or exercise your right to sell your stock to the option seller. If you do nothing then the discount broker will most likely sell your stock for you. If you buy a put on a stock or ETF that don’t own if is up to you to sell if it is ITM or it may expire worthless if you do nothing. However you could get a reminder call from your discount broker.

        Sometimes I will buy a put on a stock that I own and sell another put at a much lower strike price. It reduces my costs and gives me the opportunity to sell my stock and re-buy it at a lower price.


      • Ciao Rico,

        Very interesting, especially the last bit, buy/selling to have a chance to reduce the average price of a stock… I need to study more the buying aspect as it could prove to be a great asset in protecting the PF and lowering average costs. Thanks for the quick talk here, it was enlightening!
        ciao ciao

        Liked by 1 person

  4. Good debate in the comments! Way to go Stal and Rico!!

    Moer and more of my cash is going into to selling cash secured put options. For no, I do think there are some decent ratios out there on a selected number of stock. I almost have no US postion on, other than my deep ITM gold miner puts…

    it will be an interesting spring!

    Liked by 1 person

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