9. Manufacturer Recession? We often here that the consumer represents two-thirds of the U.S. economy. It seems that many believe this renders the other one-third irrelevant. The U.S. factory sector experienced a six month drop in its output (adjusted for inflation) as it failed to increase between November (2014) and May (2015). Meanwhile, New York-area manufacturing conditions fell so deeply in August, the -14.9 reading on the Empire State Manufacturing Survey is as poor as April of 2009. The Philly Fed’s survey’s most recent readings are consistent with the findings in the New York area, while ISM data is only representing a slowdown.

10. The Consumer Isn’t Spending Enough. Gallup data found that July was the third consecutive month when Americans spent less than they had in the same month in the year earlier. Similarly, year-over-year declines occurred in five out of the seven initial months of 2015. One would be hard-pressed to say that consumers were opening their wallets, let alone spending their gas savings windfalls.  Moreover, to the extent that consumer confidence reflects purchasing habits, Gallup’s Economic Confidence Index is near 10-month lows.

11. Fed Tightening in a Weak Economic Environment? For the last three decades, every time that the Fed has tightened monetary policy, an economic slowdown or recession has come to fruition. Then, to stimulate economic confidence, the central bank of the United States resorted to conventional and unconventional tools for lowering interest rates. Bear markets were often involved. More importantly, there are two occasions in history when annualized GDP was lower than 2.5% and the Fed still decided to tighten overnight lending rates. In both instances, recessionary pressures quickened and stock bears occurred within 6-15 months.

CONTRARIAN.

12. “Fear Index” Shows Little Fear. The CBOE S&P 500 VIX Volatility (VIX) demonstrates that the investing community simply does not anticipate a mammoth fall from grace. At 13.8, investors are only buying protection associated with a 6.5% drop in the next 30 days. And with the exception of a bit of concern related to Greece back in July, VIX Volatility has remained near its lows throughout the summertime.

VIX August

MARKET

13. Half of the S&P 500 Components are in Downtrends. In a healthy bull market, 75%-85% of S&P 500 stocks are above long-term trendlines and/or demonstrating upward price movement. In 2013 and in the first half of 2014, 85% of S&P 500 stocks exhibited these characteristics as shown in the S&P 500 Bullish Percentage Index. By the second half of 2014 and the early part of 2015, 75% became the new high water mark. Clearly, 3/4 participation would likely suffice in bolstering the U.S. large cap space. Since May, however, the deterioration in market breadth has meant that 1/2 the market is “bearish” and 1/2 the market is “bullish.” Historically, a breakdown in participation tends to foreshadow more severe price pullbacks for key indices.

BPSPX

14. Credit Spreads are Widening. Narrowing credit spreads demonstrate greater confidence in the creditworthiness of borrowers. In contrast, widening credit spreads indicate trepidation concerning the ability of corporate borrowers to service their debts. Near market tops, credit spreads are still relatively low, but they begin to rise. And this is precisely the case with respect to the 1.75% spread with BBB junk in May as opposed to the 2.16% that we see today. Investors in lower quality junk are demanding 2.16% more over quality corporate bonds – a spread that is higher than we have seen in more than two years.

Fred Graph Credit Spread

15. Flat Market Or Flat Market Plus All of the Other Stuff. According to perma-bulls, the flatness in the S&P 500 cannot tell you anything. After all, when markets were flat this far into a calendar year, they finished the year flat on one occasion, down on three occasions and higher on eight others. Batting .666 then? Perhaps not. For one thing, calendar years are not particularly instructive when it comes to bulls, bears, market tops or market bottoms. We could just as easily be talking about a July to June period or a drawn out two-and-a-half year bear (3/2000 to 9/2002).

Second, and more critically, perma-bulls are explaining away market flatness as though it exists in a vacuum. It does not. It is occurring alongside plummeting commodities, plunging foreign market stocks, deteriorating small-caps, high yield bond distress, a weak economy, a less accommodating Fed, abysmal market breadth, revenue declines, earnings deceleration, extreme U.S. stock valuations and widening credit spreads.

It follows that market flatness prior to 1930’s 28.5% collapse or 1941’s 17.5% correction should not be dismissed because of the Great Depression or the Pearl Harbor attack. Granted, the flatness of the market by itself may not tell us anything about what the market is likely to do. Nevertheless, when U.S. large caps are single-handedly holding on for dear life, and virtually every other indication is flashing yellow or red, market flatness is more likely indicative of the calm before the storm.

For those who may find the evidence presented convincing, consider lowering your overall allocation to risk assets. As I have indicated on previous occasions, if your asset allocation target is typically 65% stock (e.g., domestic, foreign, large, small, etc.) and 35% bond (e.g, short, long, investment grade, higher yielding, etc.), you might choose to downshift. Perhaps it would be 50% stock (mostly large-cap domestic), 25% income (mostly investment grade) and 25% cash/cash equivalents. Raising the cash level and modifying the type of stock and bond risk will help in a market sell-off as well as offer opportunity to purchase risk assets at better prices in the future.

In a similar vein, some investors like to take advantage of multi-asset stock hedging. Rather than using leverage, options or shorting, you consider a basket of non-stock assets that tend to do well when stocks are falling apart. The FTSE Multi-Asset Stock Hedge (MASH) Index that my colleague and I created incorporates a variety of these asset types, including zero-coupon bonds, long-duration treasuries, German bunds, gold and the Swiss Franc.

Gary Gordon is president of Pacific Park Financial, Inc.

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