Saturday, August 29, 2009

The warning signs in the US equity markets

The US stock market indicators pointing to a frothy market are now showing up everywhere. The danger signals are flashing. Here are just a few of them (not in any particular order):

1. The chart below shows short interest on SPY (SPDR S&P500), the most liquid equity security traded. It has been used as the instrument of choice to short the overall market by institutions and individuals alike. SPY short interest has fallen dramatically.

2. Insider selling has spiked, both on an absolute level as well as relative to insider buying:
TrimTabs Investment Research reported that selling by corporate insiders in August has surged to $6.1 billion, the highest amount since May 2008. The ratio of insider selling to insider buying hit 30.6, the highest level since TrimTabs began tracking the data in 2004. (prnewswire)

3. The Arms Index (TRIN) a technical indicator, defined as follows,

source: Investopedia

has hit about 0.75, the lowest level in the last 9 years. That means that the bulk of the trading volume is chasing advancing stocks. The rally is increasingly driven by speculative momentum traders - a sign of a frothy market.

4. The percentage of bullish stock advisers has spiked. From the WSJ:
The Investors Intelligence Advisors Sentiment index, which gauges the stock advice of about 150 newsletters and other paid market-advice outlets, on Wednesday said the portion of bullish stock advisers jumped to 51.6% in the past week, the highest since December 2007.

Bears fell to 19.8%, the first time since October 2007 that the percentage fell below 20%.

5. Projected PE ratio based on analyst estimates (from Bloomberg survey) is hitting new highs. With an optimistic projection of about $60 in 2009 earnings for the S&P500, the PE ratio is over 17. But taking a more realistic projection of $40, we are looking at a PE ratio of close to 26.

These are just some of the indicators warning of an impending correction. There are still others painting a similar picture.

Please note that this is not any sort of investment advice, but merely 5 observations.