7 troubling signs of the stock market

The futility of naysaying the stock market is well-documented over the last several years. Maybe the stock market is “overvalued” according to someone’s pet metric, but a crash never seems to transpire. Maybe political crises create the risk of chaos in Europe or Asia, but the global economy soldiers on without a hitch.

Regardless of investor trepidation, the S&P 500 index SPX, -0.41%   keeps setting new records. In fact, Wall Street has recorded its longest streak of record closes in two decades.

So why worry?

After all, the economy looks good. Consumer confidence is up against the highest level in 16 years, and the headline unemployment rate is back to pre-recession lows. It’s logical that the stock market would rally strongly on this data.

Of course, markets simply don’t go up forever.

I’m not saying a crash is around the corner. But as the old saying goes, if you look around the poker table and can’t find the sucker… then it’s you. I’m a firm believer in always knowing the other side of the trade to make sure I’m truly looking at the market from all angles.

Those who aren’t prepared for a market crash — or at least a 10% to 20% correction — may be caught flat-footed and suffer serious portfolio declines as a result.

For those wondering about the health of the market or simply looking for the contrarian view, here are seven troubling signs that may give you pause:

Growth may be peaking. The momentum behind the stock market has a ton of hard metrics behind it, including the ISM Manufacturing index that hit a nearly 14-year high for September. However, Goldman Sachs recently warned that some of these levels are simply unsustainable — particularly the inflated ISM reading above 60 (anything above 50 signals growth), which has typically marked the beginning of the end. “Since 1980, the ISM has exceeded 60 in eight separate episodes; four of those lasted only one month,” Goldman warns, before adding that “Investors buying the S&P 500 at ISM readings of 60 or higher have gone on to suffer negative three- and six-month returns on average as economic activity slowed.”

Record highs in economic data are good, but highs necessarily can’t last forever and some mean reversion is in order.

Earnings aren’t all grand. In a recent white paper, State Street Global Advisors made the case that “earnings may not be as strong as you think.” Chief Investment Strategist Michael Arone points to the roughly 110% earnings growth in energy from a year ago as a big driver of the overall growth for the S&P 500 — though year-over-year growth is a meager 3% total for the third quarter even accounting for energy’s big snap-back. Similarly, he points to the third quarter of 2016, which marked the end of the so-called “earnings recession” where profits were stuck in regular declines. That will fall out of year-over-year comparisons and mean a higher bar to hurdle in the fourth quarter and into 2018, even if earnings look reasonably rosy at present.

Things are too quiet. There’s a lot of talk about how the bull market is long in the tooth after running for roughly 8½ years without a 10% correction. But a recent analysis of the S&P 500 index from LPLResearch noted “33 consecutive sessions without a 0.5% daily decline, which is the longest streak since 1995” and that in 2017 the S&P has “closed lower 1% or more only four times — the fewest for a full year since 1964.”

You could say this is a new normal… or you might start wondering when the other shoe will drop.

The charts hint at trouble. BTIG chart-watcher Katie Stockton has pointed to a number of technical patterns that individually hint that caution is warranted, but collectively form a “perfect condition” for a pullback. From markets trading above long-term trend lines to sentiment indicators showing “prolonged overbought conditions,” there are some structural issues that could make it quite difficult for the stock market in general to build on this recent broad rally.

Investors are wide-eyed optimists. While there remain some vocal worrywarts out there, overall sentiment is something approaching glee. The latest survey from the American Association of Individual Investors once again points to bullishness above historic norms, and a recent University of Michigan sentiment survey showed more than 65% of respondents expect stock prices will be higher in one year — higher than even the pre-crisis euphoria in 2007 and 2008.

This is not to say stocks have to crash, but the phrase “irrational exuberance” exists for a reason. And taken in concert with the lack of volatility, it’s worth wondering if investors are being naive about the risks associated with this market.

Where’s the pro-business agenda? Most investors are biting their nails at the prospect of tax reform, knowing that a big reason this market has rallied in 2017 is because of the expectation of pro-business moves from Washington. Instead, we got a failed Obamacare repeal and heap of White House distractions. That makes the need for tax cuts — forget any pie-the-sky notion of reforms — crucial in the next two months. Policy makers know it too. Treasury Secretary Steven Mnuchin admitting recently: “To the extent we get the tax deal done, the stock market will go up higher. But there is no question in my mind if we don’t get it done you are going to see a reversal of a significant amount of these gains.”

The question for investors after this train wreck of a 115th Congress, is whether they think the former is more realistic than the latter.

“Have nots” are not fine. Beyond the hard data of the economy and real-world events that may move the stock market, it’s important to remember that the numbers don’t tell the whole story. There is a serious pessimism for many workers and consumers despite high-level metrics that are strong. That’s because, frankly, they haven’t participated in general growth we’ve seen over the last decade or so and instead are suffering from specific troubles that don’t show up in vanilla metrics about employment or spending.

If Donald Trump’s election hasn’t driven home the reality of this trend yet, then how about the latest missive from Bridgewater CEO and hedge fund icon Ray Dalio? He begins by warning that “it is a serious mistake to look at average statistics.. . because the wealth and income skews are so great that average statistics no longer reflect the conditions of the average man.” It’s a good reminder of how a theoretically healthy economy and stock market may not be as big a cause for celebration as many seem to think.