FYI | Oct 01 2014
By Peter Switzer, Switzer Super Report
I don’t want to worry you — it’s not something I practice, though I will when I think it is time. It’s not time yet but there is a death cross we have to be aware of. Did I say I didn’t want to worry you?
Technical types tell us this death cross happens when the 50-day moving average of the Russell 2000 index of small and mid-cap companies falls below its 200-day moving average – something which has just occurred.
It means the latest average of index levels of 50 days is lower than levels over 200 days (see chart below). So in simple terms, markets are less pro-stocks when it comes to smaller US companies. It can be a sign that the uptrend could be about to change.
Sooner or later
I share this with you because the Yanks have not had a 10% correction in over three years and you have to think it has to come sooner or later.
Significantly, markets are pondering if the US interest rate rise from the Fed will also be sooner rather than later. And as you might recall, I think a correction is likely when the Fed says it will raise rates, or more than likely when the markets say the economic data is so strong that the central bank will have to move soon.
The anticipation of a rate rise could trigger the correction, so how do I explain the 167-point rise of the Dow Jones index, following economic growth going from 4.2% to 4.6% for the second quarter and consumer sentiment hitting a 14-month high?
This good news could easily have created a sell-off on the basis that it would bring the rate rise forward. In reality, the market looks like it is concluding that the Fed won’t be rushing to raise rates. More experts think June is more likely that March 2015 and that’s why good economic news can take US stock markets higher.
But what about the death cross?
Well, first, it has happened three times since 2010 and only once did the market really spit the dummy. That was in 2011 when debt problems in Europe really spooked the global financial system. Also, the US copped a debt downgrade at the time.
And market hardheads think this death cross means more to the media than it does to serious investors. That said, it is a marker that, if added to a whole pile of other negative markers, could easily tell you to be careful.
On economic markers, the US economy is going great but not gangbusters enough for the Fed to jump the gun and raise rates too early. Janet Yellen is not only looking after the interests of Americans but also the global economy, with Europe and Japan going through soft patches.
The Financial Times’ investment editor, James Mackintosh, recently looked at a number of reasons to believe that we could be ignoring an upcoming crash.
He pointed to the six crashes in 50 years and how easy it was, in hindsight, to see why it happened. He underlined the following reasons for us to be worried about a crash:
• Leveraged loans to private equity groups are worryingly high and it could mean banks have lost their judgment.
• Junk bond rates are very low, which is a worrying sign of risk not being assessed properly.
• A boom in floats, with Alibaba being the poster child for excessive exuberance.
• Takeovers resemble 2000 and 2007.
• Investors are rewarding corporate buybacks, which shows a lot of companies are out of ideas and simply chasing higher share prices.
• Forward P/Es for Wall Street are very high
• The Fed will soon start raising rates and that will test out the confidence of the market.
All these issues will explain why this bull market will end but, as always, it’s all about the timing.
The one thing Mackintosh didn’t do is test out his own thesis. He simply looked for warning signs. When crashes come, interest rates aren’t around zero in places like the US and Europe.
There’s an old saying that goes “don’t fight the Fed” but it and its sister central banks are behaving differently, which makes other things different.
The only cross to get cross about
A correction will happen before the Fed raises interest rates but that will be another buying opportunity, as long as the US economy keeps reacting to low interest rates. If this process falters, it will be death for the bull markets and you will be cross if I don’t see it in time to warn you.
That’s the death cross I care about and can’t ignore!
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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