- As stocks continue to make record highs, the narrow leadership in major indexes is masking weakness lurking under the surface.
- Vincent Deluard, a macro strategist at INTL FCStone, says a correction could rock the vulnerable stock market within the next few weeks due to a “perfect storm” of bearish factors.
At this point it’s common knowledge that the stock market is being driven higher by an elite cabal of high-flying companies.
That equity Illuminati includes such companies as Apple, Amazon, Microsoft, Google, Visa, and Mastercard, which have accounted for 42% of the S&P 500‘s gains since the stock market’s correction in early February, according to data compiled by INTL FCStone.
This disproportionate contribution to index gains has been frequently cited as a bearish signal — one that highlights a troubling lack of breadth in the market. Because when a select handful of companies are doing the heavy lifting in the market, it can often mask underlying weakness.
Vincent Deluard, a macro strategist at INTL FCStone, notes that record highs for stocks during periods of low breadth have historically occurred near the end of bull markets. He cites the market collapses in 2000 and 2007 as the most contemporary examples.
Deluard also surmises that the so-called FAANG Group — consisting of Facebook, Apple, Amazon, Netflix, and Alphabet — is starting to break down. He specifically cites the lagging relative performance of Facebook and Netflix since the start of June.
But stocks have continued to plow higher, once again reaching a series of new records just this past week. This continued resilience raises the ultimate question overhanging the market: After months of warnings, when will the lack of breadth finally rear its angry head?
Deluard says it could happen in dangerously short order. In his mind, a “slow topping process” is already underway in stocks.
However, recent history has shown that deteriorating breadth on its own isn’t enough to derail stocks, which are now part of the longest bull market in history. Instead, a secondary focal point of Deluard’s bearish call is a long-standing market bogeyman: higher rates, which he notes have recently crept above the crucial 3% threshold.
“Much of this year’s action suggests a rate-driven correction is nearing,” he said in a recent client note. “The next few weeks could be a perfect storm for the U.S. equity market.”
But Deluard doesn’t stop there. He also identifies six other headwinds he expects to combine to put serious pressure on stocks — and soon. Hence his forecast that a correction could befall stocks in a matter of weeks.
1) Seasonality — The last weeks of September and the first weeks of October have historically been the worst periods for stocks.
2) Post-earnings buyback blackout periods — Buybacks have been a crucial driver of share appreciation throughout the bull market, but companies are entering a stretch where they won’t be able to conduct them.
3) Tougher year-over-year earnings growth comparisons — US stocks have been enjoying incredible profit growth over the past several quarters. As such, the bar has been raised for year-over-year comparisons. Deluard notes the third quarter of 2017 saw earnings growth climb into double digits, setting a precedent that will be tough to beat.
4) Headline risk — Deluard cites the Brazilian election (October 7), the presentation of the Italian budget (October 15), and the US midterm election (November 6).
5) Monetary tightening from the European Central Bank — The bank’s 30-million-euro injections are likely to be cut in half at the end of the month before ending altogether in December.
6) Treasury issuance will keep pressuring yields — Deluard says this will attract capital from the stock and corporate bond markets.
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