A fair number of commenters, callers and perma-bulls were relatively tough on me in May when I suggested a strategic decision to raise cash levels. They were even tougher on me when I mentioned the possibility of picking up safer havens like intermediate treasuries via iShares 7-10 Year Treasury Bond (IEF) and intermediate-to-long duration municipal bonds via BlackRock Muni Assets Fund (MUA).
There’s no doubt about it… I was early on the call. Yet the idea behind raising cash as well as bolstering one’s allocation to investment grade securities (e.g., treasuries, munis, etc.) emanated from a well-reasoned interpretation of the data. At the corporate level, earnings growth had been waning, revenue had been contracting and non-financial companies had more leverage (37%) than they had back in 2007 (34%). At the macro-economic tier, wage increases had been flatlining, manufacturing had been crumbling and transporters in the iShares DJ Transportation Average (IYT) had been dying a death by a thousand small cuts.
Keep in mind, many had been dismissing the struggles of shippers, truckers, railways and airlines as irrelevant. After all, the big industrials were not tanking in the same manner as the big transporters.
Industrial corporations – both in the Dow Jones Industrials average as well as the Industrials Sector Select SPDR (XLI) – have succumbed to the same technical pattern of weakness. Specifically, the shorter-term 50-day moving average has crossed over and below the longer-term 200-day trendline (a.k.a. “the death cross”).
By itself, a “death cross” may not be particularly meaningful. However, when both the Dow Jones Industrials and the Dow Jones Transportation Average are flashing warning signs, stock valuations as well as risk preferences become increasingly important.
Back in May and in June, valuations across nearly every metric of respectability had already reached the 2nd priciest in history (2nd only to the year 2000). Consider Buffett’s favorite indicator, market cap-to-GDP. As of this moment, the Wilshire Total Market Index market cap is roughly $21850 billion. That’s 123% of GDP. By this metric, the US stock market is only expected to annualize at about 0.3% with returns from dividends over the next decade. (See Market Cap-To-GDP chart below.)
As I warned back in early June, investors would, at that time, need to monitor the market internals to gain perspective on risk-averse behavior. Risk-off behavior had not yet materialized completely.