Taking Profits In Stocks Might Be A Good Move

Oct. 12, 2017 10:52 AM ETSPY, IVV, DIA, QQQ2 Comments
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  • Some valuations metrics are at the late 1990s peak.
  • According to the ISM and unemployment rate, the economy is overheating.
  • According to the disposable income and wage growth, the economy is decelerating.
  • According to the involuntary employment stats, there mightbe more room to run.

The stock market has had unusually quiet action in 2017 as the largest correction of the year was 2.8% which is the second shallowest maximum drawdown since 1928. That’s not necessarily a bad thing, but it shouldn’t lull you to sleep. Valuations are high as measured by the Shiller PE which is at 31.11; clearly there is some risk to the idea that great returns will continue in perpetuity. In this article, we’ll look at some of the bearish signals in this market to measure the risk and determine if you should take profits.

The chart below shows the future rolling 5 year returns of the S&P 500 as compared with unemployment. The grey bars are when the unemployment rate is below 5%. As you can see, when there’s low unemployment, 5 year returns are mostly negative and if they are positive, they are low. There is another grey bar now because the unemployment rate is 4.2%. This implies there could be another downturn or flatlining in the S&P 500.

The reason this negative correlation between stock returns and the unemployment rate likely exists is because a low unemployment rate means the business cycle is ending. When the economy gets to full employment there is little slack in the labor market which causes wage inflation. Wage inflation hurts profit margins. The Fed fights this inflation by raising rates. This leads to lending requirements tightening which increases borrowing costs and plunges the economy into a recession. The counter point to the negativity shown in the relationship between the unemployment rate and stock returns is shown below.

The Atlanta Fed wage growth tracker shows the 3 month moving average for wage growth is 3.4% which is below previous cycle peaks. The Fed has stated inflation hasn’t come in as high as it has expected

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UPFINA.com provides you with objective analysis of current events, the economy and how it all affects your life, money and personal finances.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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