Is the long awaited correction in equities now finally in motion?

Last Thursdays sharp downside move in US equity markets illustrated somewhat glaringly just how hooked on QE markets are. The Dow Jones fell by more than 150 points on, wait for it, a positive GDP number. Yes, you heard that right – a good economic number was seen as a negative for equities (& other markets). Why? Because a stronger US economy means that the Federal Reserve could start it’s called tapering operation of QE sooner rather than later.

An unexpected rise in the unemployment rate stateside on Friday last week saw the markets swing back up once again and in doing so completely wipe out Thursdays losses, underscoring the “Alice through the looking glass” philosophy that is dominating investor attitudes over the pond.

Against this backdrop there are other signs that we may be reaching a near term top in US equity markets. For example, Friday saw the release of the influential  Michigan Sentiment Index  – the measure of consumer  sentiment that is published a month in arrears and which came in at 73.2 –  four points lower than the prior reading and below analysts’ consensus estimates which  suggested a reading  of 74.5.

Moreover, Fridays figure was also the third straight monthly decline in a row. Of course the month of October included the Federal Government shut down which will have naturally dented confidence and increased pessimism but it’s worth noting that the last time the Michigan Sentiment figure fell   three time in a row was in the summer of 2011 during a period of intense debate over federal budgets the debt ceiling (sound familiar?) which lead to the fateful  S&P downgrade of Americas  “AAA “rating. (I note that fellow ratings agency Fitch warned that it was considering a cut to that AAA rating back in mid-October – though as yet they have not taken any action.)

As a foot note to the consumer sentiment index, participants are asked about their expectations for the future. The reading for this measure fell by more than 8% over the September period, plunging from 68 to 62.5 – the lowest level for nearly two years.

The Q3 Earnings Season in the USA is drawing to close but it is going out with a whimper rather than a bang too. The aggregate of companies reporting a beat in earnings estimates has fallen below 60% according to research by the highly respected Bespoke Invest Group. Despite a promising start to Q3 earnings, the percentage of companies beating estimates has steadily declined and this season has contained some notable misses including Caterpillar, NYSE Euronext, Hess, Schwab and Chevron to name a few. There are also concerns about the level of private investor involvement in the   market at present, the thinking here being that when the “shoe shine boy “ starts giving you stock tips you  know you’ve reached a top! Indicators such as the Yale crash confidence index for individual investors (which measure the perceived likelihood of a crash in the next 6 months) is showing higher levels of investor confidence since June of this year with more than 30% of participants believing we won’t see a crash in the next 6 months. Note that this a contrarian indicator i.e. the higher the reading (confidence) the bigger the likelihood of a downturn.

As Business news channel CNBC points out

“Analysts are concerned because the index hovered around these levels before the dotcom bust in 2000 and the global financial crisis in 2007-08.”

Another signal that we may being due a correction in US equities comes in the form of market breadth or if you prefer, the number of advancing/declining stocks as shown in the chart below and drawn from the  respected  US business magazine  Barons. The chart plots the daily market breadth against the  Dow Jones index up until  the close on 8/11/13. Breadth has flattened out and indeed has started to turn lower which is suggestive of the idea that market (rally) is finally running out of steam. 

Spotting the appearance of a down tune before it happens is notoriously difficult to do, as is identifying its timing, but it’s certainly prudent to be aware of the possibility at this late stage of the game. As the Guide below relays, going by a large volume of market history, this long bull market is very definitely now in its closing hours…