Admit it. You are feeling a little bit edgy these days. While you understand that fear is the elixir of investment opportunity, you also recognize that there is little glory for the last person standing on a sinking aircraft carrier.
Most in the media have been touting bull market accomplishments, job gains and economic progress. Writers regularly highlight the monster percentage gains that U.S. stocks have enjoyed since the lows hit in March of 2009 rather than discuss the reality that U.S. stocks have yet to recover inflation-adjusted highs set in March of 2000. Similarly, commentators typically celebrate monthly job growth of 200,000 without an acknowledgement that jobs paying an average of $62,000 per year have been replaced by those paying about $47,000 per year. It follows that inflation-adjusted wages have been stagnant since the recovery’s inception. And economic progress itself? Analysts often dismiss the dismal (1st quarter contraction), hype the cheerful (better-than-anticipated 2nd quarter expansion) and ignore year-over-year deceleration from 2012 to 2013 to 2014.
I have made the case before that the U.S. economy is like a tricycle. By way of review, its back two tires – inflation-adjusted family income and working-aged individuals in the labor force – have been flat for five-and-a-half years. That means the ultra-fat front tire – Fed-fueled credit for lending-n-spending – is wholly responsible for the country’s annualized expansion of approximately 2%. Instinctively, investors grasp that an end to quantitative easing as well as its partner-in-crime (i.e., zero percent interest rates) represent the equivalent of a slow leak in the front tire. It makes participants sketchy and it encourages them to pile into long-maturity Treasuries as well as gold and the greenback.
Granted, the uncertainty surrounding Fed policy is only one thing that asset allocators have to ponder. Worldwide geopolitical tensions are increasing, euro-zone members are still battling recessionary pressures, U.S. retailers are struggling, home sales are experiencing sales volume declines and job erosion at banks may be damaging the sub-sector’s stock shares. Nevertheless, the S&P 500 is a mere 2.2% off its nominal record peak at the time that I am writing this article.
Still, scaling back on extreme risk-taking is sensible and proactive. Building a cash position for buying shares lower is a way to take advantage of oversold conditions. In contrast, a “buy-every-dip” mentality works until it does not work. And probability alone suggests that a more substantive sell-off would provide a better chance to acquire beaten down shares.
Here are 5 charts that should give uber-bulls reason to reconsider their premises:
1. Small Caps Are Technically Weak and Ridiculously Overvalued. Market technicians would harp on the March and July peaks for the Russell 2000 that appear to have formed a “double-top.” Trend followers will simply remind us of the breach of key trendlines like the 200-day moving average. Myself? Year-to-date losses, unsustainable P/Es as well as a slope indicator that is poised to go negative have been keeping my allocation to U.S. small-caps at a negligible level (0%-5%).