Stock Market Crash Indicators: Three More Warning Signs

May 6th, 2014
in contributors

Money Morning Article of the Week

by David Zeiler, Associate Editor, Money Morning

Three stock market crash indicators are suggesting that the current bull market may be running out of steam and is susceptible to a significant correction.

Two of the stock market crash indicators are weakness in key sectors, and the other is a technical development on the Standard & Poor's 500 index chart.

Follow up:

Let's start with the chart.

The S&P 500 is bobbing in the 1,880, range which is not far below the all-time high of 1,890.9 reached on April 2.

Its steady climb over the past couple of years has put the index more than 20% above its 150-day moving average.

The last time the S&P 500 got that far above the 150-day moving average was in 2011, when it got slammed with a 21.58% correction.

Richard Ross, global technical strategist at Auerbach Grayson, told CNBC that investors should take the parallel seriously.

Noting that a similar decline now would shave about 20% off the S&P 500, thus taking it down to the 1,500 level, he said -

"I think that we're in exactly the same scenario. I think that's what we're staring at right here."

Ross also pointed out that the S&P 500 has sputtered for most of 2014. Ross said,

"We've stalled out at the high end of the trading range. It's really been a holding pattern for the last two months. Now look, when a market stalls and moves sideways, that's not necessarily a bad thing. But when that occurs at the tail end of a five-year bull run, with the market up almost 300% over that time... that's a problem."

Meanwhile, Gina Sanchez, founder of Chantico Global, said she sees weakness in the housing sector as a stock market crash indicator.

Pending home sales are down 7.4% on the year, and the National Association of Realtors is projecting sales of existing homes to fall nearly 4%. And new home sales for March plunged 13.4% from the same period a year ago and 14.5% from the previous month. Sanchez told CNBC -

"If you look at the pillars of the economy that should be holding us up, one of the biggest that's been doing poorly is housing. If we see further falls in housing - that could be very negative. So, I do think that there is some reason for caution right now."

Finally, Gina Martin Adams, Senior Equity Strategist for Wells Fargo Securities, sees a stock market crash indicator in a faltering sector that until recently was one of the main engines pushing stocks higher.

Stock Market Crash Indicators: The Consumer Discretionary Sector

Adams is concerned with the performance of the consumer discretionary sector, which includes retailers, media companies, apparel companies, and automakers - in short, anything consumers buy that isn't a necessity such as food.

During the recovery, the consumer discretionary sector has had a strong run, but so far in 2014 it is down about 4%.
Adams said,

"The fact that the discretionary sector is down on the year while stocks are up just a touch suggests that we've lost some leadership from discretionary. This is the sector that had been leading the market since the bottom in 2009."

And in the past that has often been a sign of broader trouble in the market, Adams said, noting that historically a slumping discretionary sector has -

"signaled at least a sideways trading range, and may even signal something a little bit more ominous."

Adams said Wells Fargo had looked at the consumer discretionary sector all the way back to 1972 and found that every time it started to underperform the market, "it has led to a near-term top in the S&P 500."

So now we have three markedly different stock market crash indicators telling us that at least a significant correction may be looming in the near future. What should investors do about it?

Money Morning Chief Investment Strategist Keith Fitz-Gerald says that the timing of a market correction matters less than the certainty that one will happen - and probably sooner rather than later.
Fitz-Gerald said -

"A market correction is long overdue and would be a welcome sign that things are, in fact, working normally. People forget that nothing goes up forever. Markets have to buy and sell for there to be price discovery. Up and down is part of the process."

Here's what Fitz-Gerald recommends:

  • Double-check your trailing stops. If the markets do fall, you'll have the chance to capture plenty of profits, just as Fitz-Gerald describes in his Money Map Method guide. (Click here to find out about getting a copy of the Money Map Method.) If the markets rise, you can go along for the ride and raise your stops to ensure even larger profits.
  • Add an inverse fund to your portfolio right now. Fitz-Gerald likes the Rydex Series Trust Inverse S&P 500 Strategy Fund Class Investor (MUTF: RYURX) fund or the ProShares Short S&P 500 (NYSE ARCA: SH). Both, he says, appreciate as the S&P 500 falls.
  • Get your buy list ready. When markets fall, good stocks get cheap. Think Tesla Motors Inc. (Nasdaq: TSLA) at $150 or Inc. (Nasdaq: AMZN) at $250. Other companies may be similarly discounted, so investors just need to be ready to pounce.

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