John Authors who writes for the Financial Times is one of my favorite pundits on the markets. This week he published a nice article listing what he believes to be the key indicators to help tell us whether a market correction (defined as a top-to-bottom fall of 10 percent or more) is imminent. Below is his list and a quick assessment on which indicators are flashing red:
1. Market Trajectory – The time to get worried is when the markets push above the upper limit of their trading band and become “obvious unsustainable”. Authors notes that the rally to date has been anything such, and has been “remarkably disciplined” in his words.
2. Market Volatility – Most corrections are preceded by an increase in volatility. Today, in contrast, the market is exhibiting record-low volatility.
3. Relative Valuation of Equities – Equity valuations far more expensive than in other parts of the market can signal a coming sell-off. As Authors points out, while a few sectors have shown some froth, overall relative valuations are largely still under control today.
4. Bullish Consumer Sentiment – Apparently, it’s time to run when investors grow “unequivocally bullish.” Today, most retail investors are still nervous about the market and holding large quantities of cash.
5. Big Upsurge in Merger and Acquisition Activity – Such activity can be evidence that corporate executives are taking valuations for granted. We have seen an uptick in merger activity recently but it’s not yet out of control.
6. Widening Credit Spreads – When investors start having to pay more and more for corporate bonds versus government bonds, this can signal that company defaults are expected to increase and this can unnerve the market. Today, this has simply not happened; indeed, the yield spread on high yield bonds is at an historic low
7. Increase in Gold Price – An increase in the price of gold often indicates increased anxiety in the market. Today we have seen a recent increase in gold, thanks to the many geopolitical tensions unfolding currently.
8. Increase in Interest Rates – Interest rate increases, raising the cost of capital and discouraging investment, can trigger a market correction. Surprisingly, just the opposite has happened thus far this year, with the decline in Treasury yields.
In short, it’s tough to argue a correction is imminent.
