In my long career as a passionate follower and participant in the financial markets, technical analysis has always been the driver of my trading and investment decisions. However, every once in a while, the fundamental picture is so clear and compelling that investment action is justified and even demanded.
This may be one of those times! The chart below is borrowed from John Hussman's latest weekly commentary. Mr. Hussman is President of the Hussman Investment Trust and Chief Investment Officer of the Hussman Funds.
This chart represents the Median Price to Revenue Ratio of the S&P 500 Index Components. This ratio is now approximately 40% above the "extreme" level posted at the 2007 stock market peak and about 50% above the overvaluation level posted near the 2000 peak. Historically low interest rates and improved corporate profit margins may explain part of this price expansion, but given the current valuation level in this metric, the bullish case for U.S. stocks from here looks questionable (at best).
While I consider myself a strong student of history when it comes to extraordinary price moves in the financial markets, I've struggled with the rational that is needed now to participate on the long side of this stock market. And despite the fact that my computer trading system has YET to trigger a sell signal, I now have a substantial short position in the S&P 500 and in the Russell 2000 Indexes.
Bottom Line: While I think the current environment is top-heavy with potential risks for stock investors, even without a black swan event, the fact that the U.S. Federal Reserve is now forecasting a faster track for interest rate hikes this year (a March hike now looks likely to me) should be enough to contribute to a serious stock market correction over the very near term.
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| S&P 500 Index with 3-Standard Deviation Bollinger Bands |
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| Russell 2000 Index with 3-Standard Deviation Bollinger Bands |
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