Red Shoots? Amid the Holiday Cheer, is a Market Peak Brewing?

This is always a most interesting time of year in the investment world. The holidays and the conclusion of a strong year for U.S. stock market indexes make for an “any news is good news” feeling. I see it on TV, in my reading of other strategist’s views (except for the usual perma-bears) and in discussions with “people on the street” so to speak. That said, there are plenty of people (myself included) who look at the kind of market recovery we have had since early 2009, and at the possibility that the vast majority of it is due to one simple factor: a half-decade of artificially suppressed U.S. interest rates and the domino effect it has had on most world markets. It is true that many Emerging Markets are having a horrible year, and that just adds to the temptation to believe that there is something unsustainable going on with the U.S. stock market. Meanwhile, many corners of the bond market have had a flat to negative year, and strategies that combine equity investing with a hedging component (like those we manage at Sungarden) are doing well, but pale in comparison to the run amok S&P 500, Dow Jones Industrials and Nasdaq performance in 2013.

Put it all together and it has the feel of being too easy to make money right now. There are three times in my career when I felt like that: 1987, 2000 and 2007. Look up your market history and you will see that while I don’t see imminent signs of a rough market, it does appear that some “red shoots” are not forming. FYI, a red shoot is a term I just made up. Whereas a “green shoot” is a piece of good news in an otherwise difficult economic environment, I define a red shoot as a piece of potentially bad news among a sea of green stock market profits.

Along with Sungarden Research Analyst Mark Jakupcik, I scoured the web for some of my favorite market indicators. Here is a summary of where several of them stand as 2014 approaches.

Investor Sentiments:

AAII Sentiment- The AAII Investor Sentiment Survey gauges its member’s outlook on the market by measuring the percentage of members who are bullish, bearish, or neutral on the stock market for the next six months.

47.3% - Bullish

24.4% - Neutral

28.3% - Bearish

Comment: this figure has flopped around this year and bears are creeping up. In a backwards way, that is good for the stock market (since the crowd is often wrong). This could reflect the general confusion that exists in a world driven by Central Bank decisions.

Misery Index– The misery index is the sum of the unemployment rate and the inflation rate. It is currently measured at 8.26, which is the lowest it’s been in 12 months.

8.26 – Bullish

Comment: this indicator being under 10 (mainly due to low inflation) is a good sign. The red shoot is that inflation may be inevitable into 2014, once consumers get comfortable that the recovery from 2008, though slow, is real. That in turn could give providers of goods and services a reason to raise prices. And inflation could be a big stock market issue. Why? Because there is a generation of investors who never had to confront rapidly rising cost of living. There would be sticker shock everywhere.

Morningstar Fair Value– Morningstar measures the price to fair value ratio for every company they follow which they then aggregate into one number each day. <1 = Undervalued, 1= Fairly Valued, >1 = Overvalued

1.03 – Bearish

Comment: this is a very slow moving one, but the fact that it is over 1 is a cause for eventual concern.

Bob Shiller’s Cyclically Adjusted Price to Earnings (CAPE) ratio– The CAPE ratio incorporates inflation adjusted earnings from the last ten years into the normal P/E ratio. A measurement above the long-term average of 16.5 indicates that the market is overvalued.

25.24 – Bearish

Comment: where I come from (New Jersey!), when something is 50% above a level considered “overvalued,” that is trouble. When will this lead to a market decline? That’s the great unknown. Markets can stay overvalued for a long time.

NAAIM Sentiment– The National Association of Active Investment Managers measures their member’s equity exposure and averages them to find the average long or short position. The current measurement indicates that the majority of NAAIM members are fully invested.

101.45 - Bullish

Comment: when the most active managers are fully invested, that tells me that they are enjoying the ride, but that can change very quickly.

Consensus Bullish Sentiment Index– The index only includes opinions from brokerage houses and advisory services that have been published and are available to the public. A reading of 75 or above indicates that the market is overbought.

77% - Bearish

Comment: remember when the media brought attention to how seldom the brokerage firms would issue a “sell” recommendation? It looks like nothing has changed. This is why I tend to use independent research and proprietary research to make portfolio decisions.

Conclusion: Red Shoots are out there, but they are not prevalent…yet. This is just a sampling of the many sentiment and valuation indicators we follow at Sungarden.If you have any favorite indicators you think people should be following, contact me at [email protected]. We are always hunting for new ways to assess the tradeoff between reward and risk in the markets.

© Sungarden Investment Research

Read more commentaries by Sungarden Investment Research