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Reasons Are Mounting To Be Very Cautious About Stocks Right Now

From Mike Burnick: Last week, I traveled to Orlando for the Money Show, where investors, analysts and public companies gather to exchange investment ideas. I like the Orlando event best, because it’s early in the year, so you get to listen in on the experts’ investment outlook for the year ahead.

This year, that outlook could be best described as cautious, which stands in sharp contrast to the bullishness on display in the stock market itself so far in 2017.

It’s been said many times that bull markets climb a “wall of worry” but there seems to be a shortage of worry these days among professional investors.

The CBOE SPX Volatility Index (VIX), the stock market’s favorite fear-gauge, has collapsed in recent months, hitting a low under 10 at the beginning of February. That’s the lowest level of market volatility recorded in two-and-a-half years … no worry here!

And the percentage of Bullish Investment Advisors hit 62.7% last week, a 12-year high! No worry here, either.

Of course both of these metrics should be viewed as contrary indicators in my view. That is, whenever volatility collapses and the majority of investors are bullish, it tells you there’s far too much complacency in the markets … and you can typically expect a correction.

In fact, Bullish Investment Advisory sentiment has been particularly good at signaling a market top whenever it gets much above 55-to-60% bullish … which it has been for 11-straight weeks now.

Getting back to the Money Show presentations, there was one that really stood out for me in terms of taking a cautious tone about markets, which is a reality check for this overbought market. It was delivered by none other than Bruce Johnstone, managing director at Fidelity Investments.

As far as street-cred goes, it doesn’t get much better than Johnstone’s resume. Along with Peter Lynch, there aren’t many mutual fund managers with a more legendary track record at managing money.

Johnstone posted total returns of 1,100% for the Fidelity Equity Income fund from 1972 to 1990, and remember, the first decade of his tenure were very difficult years for the stock markets,

Johnstone likes to evaluate what he calls the three pillars of a bull market to form his outlook for stocks. They are:

1. Rising corporate profits..

2. Benign inflation, interest rates and ample liquidity.

3. Reasonable valuation.

In turns out, today’s stock market doesn’t rate very high marks on these metrics.

In terms of profits, Johnstone noted that rising earnings are needed to keep fueling a bull market.

Historically, corporate profits have grown about 7% annually, but in 2016 S&P 500 earnings grew just 0.5% from the year before!

So the pillar of corporate profits is crumbling, unless earnings accelerate this year as expected.

Johnstone’s second pillar (Interest rates, inflation and liquidity) is also under stress today.

The Fed has raised interest rates only twice in the past two years, and rates are still near record lows. But the Fed’s rhetoric has turned more hawkish recently, indicating a faster pace of rate hikes to come.

Inflation is accelerating at a 2.5% annual rate, and the Fed is openly discussing how to reduce its bloated balance sheet, by starting to unload all the Treasury bonds acquired in multiple rounds of QE since 2008.

This indicates tighter monetary conditions and potentially much higher interest rates, draining liquidity from the economy.

Finally, when it comes to market valuation, Johnstone noted that stocks trade at a high price/earnings multiple right now … with a weak denominator (earnings growth) and a rising numerator (stock prices).

Also, corporate profit margins appear to have peaked, meaning accelerating profits, and expanding P/E ratios, will be hard to come by unless top-line sales growth really picks up.

So this pillar looks suspect too.

Bottom line: Most of the so-called experts you hear speak in person, or on CNBC typically “talk their book.” Meaning a rosy outlook and optimistic analysis. Fidelity is the world’s largest mutual fund company and so has every incentive to talk-up the stock market. That’s why, when Fidelity’s managing director strikes a cautious tone about stocks, you better sit up and listen. I certainly did.

The SPDR Dow Jones Industrial Average ETF (NYSE:DIA) fell $1.09 (-0.53%) in premarket trading Friday. Year-to-date, DIA has gained 4.54%, versus a 5.01% rise in the benchmark S&P 500 index during the same period.

DIA currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #6 of 76 ETFs in the Large Cap Value ETFs category.

This article is brought to you courtesy of Money And Markets.

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