Risks are stacking up for markets attempting to recover from the latest provocation by North Korea and the mounting damage of Tropical Storm Harvey.
Citigroup Inc. strategists including Jeremy Hale cite “worrying developments” that may signal the approach of a correction in stocks, while Commerzbank AG finds growing evidence of bearish sentiment in bond funds. Here are some of the red flags:
The pairwise correlations between the S&P 500 and its industry sectors have fallen near levels that preceded the last two bear markets, according to the Citigroup strategists. The previous downturns in stocks started when correlations re-established themselves.
Underperforming transport stocks are another concern. The Dow Jones Transportation Average, a gauge of airline, railroad and trucking companies, has fallen about 5 percent from its July 14 high. The index’s decline from its 2014 peak led a similar move in the S&P 500 by about seven months.
The ratio of outstanding puts to calls on the S&P 500 has risen to levels last seen in the late-2015 market sell-off, according to Richard Turnill, BlackRock Inc.’s chief investment strategist. The ratio for German stocks has also risen. The move to boost downside protection shows investors are getting nervous, he said.
Fund flows show bond investors are also shunning risk. While high-yield funds suffer ‘considerable’ redemptions, cash has flowed into those that invest in government debt, according to Commerzbank strategists including Alexander Kramer and Ulrich Urbahn.
Equity investors are willing to pay more for protection against losses than gains. So-called equity implied volatility skews are above the 10-year average, according to the Commerzbank strategists. This implies they are willing to pay more for downside protection than upside potential compared to the last decade.
Bond rates in free fall, flattening the yield curve, and a narrowing stock market leader board — at some point their message starts to matter for the S&P 500, right? A few analysts say yes.
Not “matter” for just for a couple of hours, the way North Korea was a nuisance for equities Tuesday morning after fresh provocations from Kim Jong-Un. But in a more pronounced sense, as signals that portend lasting pain.
This is a warning for stock traders entranced by a market that remains resilient to surprises. Even though the S&P 500 is less than 1 percent away from a record set this month, the best move is to wait out more selling, according to Strategas Research Partners.
Breadth has deteriorated as the benchmark gauge has been mostly listless. About 43 percent of stocks in the S&P 500 are currently trading above their 50-day moving averages, near the fewest of the year and down from 74 percent last month, data compiled by Bloomberg show.
“Tepid momentum is often consistent with below average returns in the short-run,” Strategas analysts led by Chris Verrone wrote in a research note Tuesday. “We continue to believe that an oversold condition will likely need to develop before a year-end rally can take shape.”
Investors have increasingly pushed into perceived haven assets in the second half of 2017. The yield on the 10-year Treasury bond is down 25 basis points since July 7, and gold prices are up about 8 percent over the same period.
While lower interest rates have been a hallmark of this bull market, used to justify virtually any valuation, the lens through which investors view them is nuanced. Too low and they start to suggest economic stress.
After rallying in sync for much of 2017, bonds and stocks have become disjointed as economic data misses expectations for the third straight month. The one-month correlation between the S&P 500 and the Bloomberg Barclays Global Aggregate Bond Index is at the lowest since April, with the S&P 500 flatlining since its Aug. 7 high, as 10-year yields dropped 11 basis points.
Caution is the buzzword at Raymond James & Associates, which is advising clients to be patient and pick their entry points carefully amid thinner markets and gold prices that look poised to break through a “longer-term downtrend,” according to Andrew Adams, a strategist at the firm.
“We continue to exercise patience in the near term, as most of the indicators we follow are still weak-to-neutral and not really flashing that ‘attractive opening’ that we look for,” St. Petersburg, Florida-based Adams wrote in a note Tuesday morning.
With the dollar sitting near the lowest level in 2.5 years and the outlook for government funding murky, some traders say it may be the time to take the chips off the table.
“Perhaps take a percentage of your portfolio and put it in cash,” said Stephen Carl, principal and head equity trader at Williams Capital Group LP in New York. “You don’t go broke taking profits.”
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