Stock Market: Why Investors Should Be Cautious After Five-Year Bull Run

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The stock market celebrated the five-year anniversary of its bull run this weekend. Investors should be very cautious for many reasons, investing strategists say.  They believe the stock market is long overdue for a healthy pullback before chugging higher again. SPDR S&P 500 ETF (SPY) , the most popular measure for the U.S. stock market, ended the week at $188.26, up a robust 181 percent from its bear-market low of $67.10 a share on March 9, 2009.

Warning signs abound that the U.S. stock market is poised for a nasty nosedive, says Brad Lamensdorf, a stock market strategist and publisher of The Lamensdorf Market Timing Report.Investors are overly optimistic as is typically seen at stock market peaks, says Lamensdorf, who manages the AdvisorShares Ranger Equity Bear ETF (HDGE) with $153 million in assets.

To be sure, Lamensdorf has called for a stock market correction since at least the middle of 2013, a year in which the SPDR S&P 500 ETF (SPY) soared 32% and his ETF short sells stocks to profit from falling prices.

“Since February 10th there has been increased (trading) volume in penny stocks relative to the NASDAQ Composite volume,” Lamensdorf wrote in his newsletter released March 8. “This activity is a warning sign; traders are becoming extremely active in penny stocks, which are traditionally speculative in nature.”

He says margin debt, or the money investors are borrowing from their brokers for stock trading, has also reached a new all-time high. This indicates excessive investing speculation, which is a contrarian warning sign because the crowd is usually wrong. The stock market’s value relative to gross domestic product is fast approaching a level seen at the height of the technology bubble in 2000, suggesting stocks are getting overpriced.

Foreign investors appear to have already turned cautious about the five-year bull run without having to be told why. Their buying in the U.S. stock market has tumbled to a 20-year low. The amount of money invested in stocks is nearly four times as much as the amount invested in money market funds and is the highest in 30 years, Lamensdorf added.  This warns that new money on the sidelines available to push stock prices higher is depleting. The ratio of money invested in stocks versus money market funds reached extreme levels at the market peaks of 2000 and 2oo7 as well. Lamensdorf has put about a third of his money in short positions to profit from falling stock prices.

Whenever price indicators reach extremes, they eventually reverse to their long-term average, a phenomenon known as mean reversion.The stock market’s price-to-sales ratio recently reached a 50-year high.The S&P 500 trades at forward price-to earnings ratio of nearly 16, the tallest seen since the fourth quarter of 2008, according to Thomson Reuters. The average stock trades at a price-to-earnings ratio that is 20% higher than its five-year average and very few stocks are undervalued, according to  Dow Theory Forecasts, a 68-year old stock market newsletter published out of Hammond, Indiana. Investor behavior reminds the publishers of that seen in the run up to the technology bubble in 2000.

“Small investors are day trading again, helping drive business at some discount brokerages near record levels,” the newsletter’s March 10 edition stated. “Meanwhile, the number of initial public offerings reached a more than 10-year high for the first two months of 2014… and shares of unprofitable companies are leading the stock market’s advance.”

Dow Theory Forecasts’ publisher recommends investing in energy stocks, which have underperformed the stock  market over the past three and 12 months but have superior potential to grow profits over the next five years.

“We have a cautiously positive outlook for energy stocks particularly those leveraged to U.S. production,” Dow Theory Forecasts stated. “According to the U.S. Energy Information Administration, monthly oil production in this country averaged 235 million barrels in the three months ended November, up 69% from five years ago and the strongest since 1989.”

The stock market reached a five-year anniversary this month after experiencing only three notable corrections: a 17-percent drop in 2010, a 21-percent sell off in 2011 and a 10-percent decline in 2012. Stock market investors should be cautious. Why? Because the bull run inevitably will run out of gas as it always does and it is perfectly normal for it to do so.

By Quynh Ho

Brad Lamensdorf, publisher of The Lamensdorf Market Timing Report
Dow Theory Forecasts

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