The appetite for stock risk is softening, yet few people are talking about it. Take a look at the “Advance-Decline Line” – one of the more popular technical analysis tools for identifying potential trend reversals. It dropped below a short-term moving average (50 SMA) in early August; it is now below the key trendline in mid-September. More notably, the AD Line may be diverging from the S&P 500, as the latter is a mere 1.1% off of an all-time record high.
The evidence may or may not be particularly compelling. After all, the AD Line confirmed the broader bull market as recently as two week ago. On the other hand, Bloomberg reported that nearly one-half of all stocks in the NASDAQ Composite are down at least 20% from a 52-week peak; similarly, three-fifths of Russell 2000 companies have hit bearish 20%-plus declines. The uncertainty with riskier shares directly contrasts with the S&P 500. Bloomberg data confirm that a mere 6% of constituents are currently dealing with bear market downturns.
Is it possible that investors are beginning to worry that a 10% correction is rapidly approaching? Possibly. After three years without corrective activity, some folks may be shunning the shares of corporations that tend to suffer the most in downdrafts.
Granted, market participants have come to believe that central banks will continue boosting financial prices and squashing volatility through a combination of conventional and unconventional policy measures. What’s more, corporations have deployed balance sheet dollars to repurchase stock shares. Nevertheless, global economic weakness as well as geopolitical conflict cannot be ignored indefinitely.
In May, the Organization for Economic Cooperation and Development (OECD) projected 2014 and 2015 expansion for the euro zone at 1.2% and 1.7% respectively. Today, they predict 0.8% for 2014 and 1.1% for 2015. The OECD downgraded growth projections for the U.S. and Japan as well. Keep in mind that these economic downgrades have come in spite of massive central bank (e.g., Federal Reserve, European Monetary Union, Bank of Japan, etc.) intervention.
Shouldn’t slower growth in Europe drag on the revenue and earnings of U.S.-based multinationals? One would think so. However, the European Central Bank (ECB) will eventually engage in the same type of money-creating, bond-buying policies that the U.S. and Japan have been promoting for years. (That is what the credit agency Standard & Poor’s anticipates.) Expectations notwithstanding, it would be difficult to advocate an increase in one’s allocation to unhedged European stock ETFs until the ECB serves up greater clarity.