Three signs that the stock market rally is on borrowed time
By
Associate Editor
David Stevenson Oct 29, 2010
Print this article
Yesterday was another 'risk on' day in the stock market. The FTSE 100 rose 0.6% as investors' nerves were calmed by a lower US dollar. When this falls, most other assets rise.
This week, though, there's been a wobble about QE2 - the next round of quantitative easing, aka money printing. Market rumours are that the US Federal Reserve will now print less money than had been expected.
For global share prices, that was seen as bad news. Wall Street and the City want more, as Dominic Frisby talked about yesterday.
But just how much QE hype is baked into stock values? The answer is worrying. Let's have a look...
US sentiment indicators point to a drop
In stock markets (as in life) anticipation is often better than reality.
So on the basis of the stock market rally after the last QE bout, maybe it's no great shock to see share prices climb on both sides of the Atlantic in the hope of plenty more. That's even though we still don't know how it will all play out in kick-starting the US economy.
But this hasn't stopped Joe Public getting very excited about what the Fed may or may not announce at its meeting next week. And there's a great way of gauging this. Each week, the American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months.
If we subtract the 'bear' from the 'bull' reading, we get a net balance of market optimists. And history shows that the higher this balance rises, the further the market has climbed into dangerous territory. In other words, the keener private punters are on the US market, the closer it is to a big drop.
And when the US market sneezes…
What's more, the US and UK stock markets tend to move in lock step. What starts in the States soon rubs off over here. That means this AAII survey is as good a guide for the FTSE 100 as it is for the Dow Jones and the S&P 500 indices.
The blue line on the chart below shows the percentage of bullish respondents in the latest AAII survey, minus the proportion of bears. The red line is the FTSE 100 index. The 'bulls-bears' balance has now hit +30. That's the highest level for more than three years, going right back to 2007's market peaks.
Whenever the net balance has risen as high as this, the message for the overall market has been clear. It's time to take cover - the average FTSE 100 fall has been around 17% in quite short order. Despite all the QE hype, history tells us that this is a time to be very wary.
Special FREE report from MoneyWeek magazine: Don't be fooled - house prices will fall again!
- Why UK property prices are set to collapse by 30%
- When it will be time to get back in and buy up dirt cheap property
Investors may be all spent out
In addition, investors are getting through their spare cash. The next chart again has the FTSE 100 in red. This time it's compared with the monthly change in sterling and money market deposits (in purple).
Note that the latter is displayed in ten-month moving average format. That may sound complex, but in essence it smoothes out the volatile monthly numbers. I've used it as a proxy for how much of investors' money is sitting around waiting to go into stock or bond markets.
Cash balances were actually built up during the market's recovery between 2003 and 2007, and topped out during the 2008/early 2009 crash. But since then, money market funds have been ploughed into the markets. Indeed, the cash change has now gone negative, meaning liquidity is being consumed. This doesn't bode well for stocks.
Meanwhile, US money market funds show a similar picture. But as ordinary American investors have been piling into the market, whose shares have they been buying? Here's the really scary bit I mentioned earlier. In the US, there's been a mega-boom… in 'insider' selling.
And insiders are bailing out too
What's this? First, it isn't to be confused with insider dealing, where people get locked up for using privileged information to make illegal profits. In the US, the term 'insiders' is used to describe directors, key employees and large shareholders. They can trade at certain times provided they don't do so using "material non-public" knowledge.
I'm not going to get stuck into too much compliance stuff here. But clearly, legal insiders will still have a head start when it comes to knowing how a business is really doing. So when these insiders deal - as with directors in the UK - it's well worth noting what they do.
And right now, "insider selling is as high as we have ever seen", says Alan Newman - many thanks for this - in his Crosscurrents newsletter. Further, he calculates the ratio of insider selling to buying is a terrifying 3,177 shares sold compared with each share bought.
This "frantic dumping" shows just where "the true value for corporate insiders lies", says Alan - "in cashing out their own shares. Their actions speak volumes for the veracity of the current rally".
How investors should react
All in all, then, the market omens aren't looking good. So what can you do to protect your own money? Despite our concerns, there are still some investments we reckon are worthwhile holding (and I'm not just talking about gold!).
We look at several in one of our latest subscriber-only articles - it's well worth a look. I can't run through them here - that wouldn't be fair to subscribers. But if you are one of the latter you can read the article here - if you'd like to become one, get your first three copies of MoneyWeek magazine free here, plus instant access to everything on the website.
Our recommended article for today
'Alternative' energy is all well and good, but it can be unreliable - if the wind doesn't blow, the lights don't come on. But 'grid-scale' power storage is evolving rapidly. And that will change the economics of the industry, says Nick Hanna. Here, he tips the best way to invest.
Published in
Stock markets
| More
articles
by
David Stevenson
Related articles
-
By Merryn Somerset Webb, May 18, 2012
-
By Phil Oakley, May 17, 2012
-
By John Stepek, May 17, 2012
-
By Tim Cockerill, May 04, 2012
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.