Reuters / Brendan McDermid
- The US stock market is currently at all-time highs, but one Wall Street expert argues a sudden sell-off may be in the cards for May — one that would be worse than the February 2018 correction.
- Vincent Deluard, a macro strategist at INTL FCStone, breaks down four pieces of evidence that support his immediate-term bearish view.
- Follow all of Business Insider’s coverage of the 2019 Milken Conference here.
Stocks are at record highs, and many experts on Wall Street will tell you conditions look ripe for continued strength.
Vincent Deluard is not one of them.
In fact, the INTL FCStone macro strategist — who regularly publishes thoughtful research on a wide range of topics — thinks the bottom may drop out of the market this month.
That may seem like an aggressive forecast give the tight time frame, but Deluard lays out a compelling four-part argument to support his near-term bearish view. If his overall take had to be summarized into a single theme, it’s that the drivers supporting stock strength will soon be impediments.
Here are his four arguments:
The age-old saying for stock-market pundits is "sell in May, then go away." While Deluard’s argument is far less simplistic, it does call upon historically weak equity performance this time of year.
Deluard says that, when viewed in tandem with the other three elements on this list, this is a troubling reality that could send stocks tumbling into a correction.
"To the extent that stock market seasonality does exist, it will stop supporting stock prices at the end of the month," he said in a recent report. "Since 1973, stocks have tended to flat line from mid-May to the end of November."
2) The melt-up in stocks is already complete
A great deal of recent stock-market punditry has focused on a so-called melt-up. While such an occurrence does push equities higher, it’s usually viewed as a late-cycle indicator — a last-gasp effort for traders to ride the momentum wave higher.
For those who think the melt-up can continue indefinitely, Deluard points to the S&P 500‘s four-month Sharpe ratio. The measure has been a historically reliable way to assess risk-adjusted excess return.
As you can see in the chart below, the only time the metric has been higher was in late 2017 and early 2018 — the period immediately preceding a vicious stock-market correction.
"Needless to say, this did not end well," Deluard wrote.
3) Multiples are "entering the danger zone"
Stretched valuations have been a frequent target for stock bears throughout the more than 10-year bull market. And so far, those pessimists have been proven wrong.
But that hasn’t dissuading Deluard from making a similar argument. He notes that, at 17 times earnings, the S&P 500’s multiple is already two points higher than its average since 2009.
Once again, the point of comparison is January 2018, ahead of the February meltdown. Deluard highlights the fact that conditions might be even more ripe for a correction this time around because there’s less earnings growth expected for US corporations.
"January 2018 was the only time stocks got this expensive in this cycle, but earnings were expected to grow by 30% in the next 12 months, versus 12% today," he said. "Note that even very strong earnings growth did not prevent a 10%+ correction in the first quarter of 2018."
He continued: "The combination of elevated valuations and poorer earnings growth prospects could trigger a larger correction this time. The stock market will be especially vulnerable to a correction as multiples are entering the danger zone."
4) The shorts have vanished
Upon first glance, the lack of shorts in the US equity market may seem like a bullish signal. But it’s actually the opposite.
A healthy stock market generally has an underlying short component of people simply protecting their downside. Those shorts, in turn, can serve as valuable dry powder when investors get more bullish and want to get long.
On the flipside, a low level of short interest — like we’re seeing right now — can actually signal that market pessimists have turned bullish. That’s exactly the type of overexuberant behavior that portends sell-offs.
According to Deluard’s findings, short interest on the six largest US equity exchange-traded funds currently sits at 7.4%, one of the lowest readings on record.
This rally may be ‘the most hated bull market in history,’ but the market is filled with ‘fully-invested bears,’" Deluard said.
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