Tags: ETF | stock | correction | VIX

5 Signs That the Stock Market Could Be Near Another Huge Correction

By    |   Monday, 16 Mar 2015 08:44 AM

You might think I hang around with a bunch of stock market junkies. But I don't. Don't get me wrong, I wish more of my friends were into stock investing so we'd have that much more in common, but we don't.
 
We do have a ton of things in common, such as our commonality of our Christian faith, our involvement in our local church and our love of UFC fights. (I know, some of you probably think the last one doesn't mesh too well with the former, but you'd be surprised at how many dedicated Christians there are in the mixed martial arts world. They're huge witnesses for Christ in their field.)
 
So since I don't have a lot of friends who are in the stock market, when they suddenly get a lot more interested in stocks, I know that stocks are getting really elevated and that stocks are likely getting very risky at that point.
 
But thankfully, while this can be an initial signal to look deeper into the market, I do have some more quantifiable indicators that I look to. And the bad news is that ALL of them are very concerning right now.
 
The first troubling signal is the recent steep rise in the dollar. Now, you'd think that would be a good thing wouldn't you? However, here's why that's a problem. Most of our biggest companies here in America are multinationals. In other words, they do a ton of business all over the world.
 
Well, when they earn money overseas and then convert it back to their U.S. dollar-based books, the earnings aren't as great as in the times when they earn money overseas in stronger foreign currencies and then convert them to a dollar-based book.
 
And right now, the dollar is more elevated than at any time since 2001-2002. You see, the dollar had been rising since 1995 and peaked out in 2001, but the buck had gotten to a high enough level that we all remember what happened in the early 2000s . . . the stock market had a huge crash.
 
During that time, the S&P 500 went from more than 1,550 in early 2000 down to the 700s in 2002 before the index bottomed.
 
In other words, this steep rise in the greenback caused the S&P 500 index to drop by more than 50 percent!
 
So this huge dollar rally could end up hurting our stock market big-time in the weeks and months ahead.
 
Secondly, the CBOE Volatility Index (VIX) is way too low. The VIX measures how volatile the S&P 500 is. It's also known as the "fear index" because when the readings on the VIX are unusually low, investors have become complacent and that's one of the most dangerous times to be in the market.
 
When the VIX hits as low as the 10-13 area fairly often, you know that investors are very complacent — they're overly bullish on stocks and that's typically when reversals lower in the stock market tend to happen.
 
Well, in the past year, the VIX has spent a ton of time being at 13 or below. And now it's finally starting to come back up above that level. So if we're not at the beginning of a major correction lower in the stock market, then it's not far off. The fear of investors is low, and that's when disaster usually strikes for them.
 
My third major concern is that the average price-earnings (P/E) ratio for the S&P 500 is getting on the high side again. That means investors are paying too high of a price for their stocks relative to the level of earnings that these companies put out.
 
When the S&P 500 typically tops out, it's between a P/E of 20 and 23. Occasionally, it may make it to a P/E of 25 before crashing. Well, right now, the P/E ratio of the S&P 500 is at 20.5. So we've entered the valuation zone were investing in this broad-based index has now become dangerously expensive.
 
The fourth thing that concerns me about the market is the amount of margin that's being used by traders and investors right now. The New York Stock Exchange tracks margin debt levels and make the data public. Now, admittedly, this data is reported with a huge lag. For instance, the latest NYSE Margin Debt report came out in January.
 
However, the thing that is the most concerning about this "margin debt trend" is that it shows us that investors have gone out to the end of the limb by margining their accounts to the hilt.
 
While margin debt levels were at their largest as of February of last year, they're still hanging out near peak levels as of this January. And when investors are margined heavily, it can make selloffs even worse, as forced selling happens by the margin clerks of the brokerage firms.
 
Since people borrow the money from their brokers, their brokers begin to cover their risks when they feel they are getting high, which is when large corrections begin with the market at elevated margin debt and high P/E levels.
 
In addition to this forced selling, investors panic and sell like madmen too. Between all of this, it compounds the losses of investors and starts a vicious cycle in motion that takes at least months to work itself out but sometimes can literally go on for a year or two as these declines continue.
 
And the final concerning sign that I see is that the S&P 500 is as far away from its 200-week moving average as it was back in 2000 and 2007, when there were huge crashes to the tune of at least 40 to 50 percent in the two to three years that followed.
 
Well, I believe we're back at this spot once again. I can't tell you that stocks will crash tomorrow, next week or next month. But what I can tell you is that all of the signs are there that have preceded all of the other market crashes during the last 15 years.
 
So what's an investor to do? Well, one thing that you might do is lighten your exposure to the overall stock market by taking part of your position to cash. In other words, you'd be selling part of your positions.
 
Ok, but what tends to go well when stocks sell off? Not a lot. But there are some things that can.
  • Value stocks are a great place to start because they're stocks that have been beaten down and haven't followed the market upward into lofty valuations. These stocks tend to have low P/Es and many times very high dividend yields. If you'd like to see some examples of those, come follow what I do in the Ultimate Wealth Report at www.ultimatewealthreport.com.
  • Gold and silver tend to do well when stocks perform horribly. I tend to buy exchange-traded funds (ETFs) that track these metals, such as the SPDR Gold Shares ETF (GLD) or the iShares Silver Trust ETF (SLV). However, some people may decide to buy actual physical coins.
  • Certain foreign currencies tend to have an inverse correlation to U.S. stocks, such as the Swiss franc and Japanese yen. There are a lot of reasons for this, but you can track these currencies with ETFs in your portfolio with the CurrencyShares Swiss Franc ETF (FXF) and the CurrencyShares Japanese Yen ETF (FXY). I'd personally start with the franc first, if you delve into these.
  • Going out a little further on the risk curve, you could invest in the iPath S&P 500 VIX Short-Term Futures exchange-traded note (VXX), which loosely tracks the VIX. As stocks begin to decline, the volatility kicks up very quickly and as a result, VXX can soar very quickly. However, if the market remains well-supported, the price of VXX can bleed lower like a tire with a slow leak. So this approach works best when you feel that the stock market getting slammed is very near. And once the huge decline is over, you'd need to be out of VXX quickly in order not to give back your profits. 
So I've expressed my concerns about the market but I've also shown you some very empowering moves that you can take to help lessen the blow to your overall stock portfolio too. Don't react in fear. Instead, respond by positioning your portfolio accordingly so that it can stem the decline of the portfolio and make some money during these volatile times we're in.
 
God bless!

About the Author: Sean Hyman
Sean Hyman is a member of the Newsmax Financial Brain Trust.
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SeanHyman
You might think I hang around with a bunch of stock market junkies. But I don't. Don't get me wrong, I wish more of my friends were into stock investing so we'd have that much more in common, but we don't.
ETF, stock, correction, VIX
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2015-44-16
Monday, 16 Mar 2015 08:44 AM
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