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posted on 13 August 2016

Bear Market Countdown

by Richard Stavros

Investing Daily Article of the Week

It's hard to say which month might be the most dangerous for stocks when the market is as overvalued as it is at the moment. But we're now in the three-month period that's historically proved especially treacherous for the market.

Last August, for instance, we saw the market tumble following the collapse of China's stock market. Some market analysts are calling for a decline in September if the Federal Reserve decides to raise rates. And October has been a notoriously bad month for the market, with some of the biggest declines in history.

The silver lining - if there is any - is that a broad market decline could offer an opportunity to pick up some of our favorite utilities at more reasonable prices.

Let's take a look at some of the more fearful prognostications.

Goldman Sachs recently warned clients to "underweight" the stock market for the next three months, advising their investors to hold some cash. The investment bank noted that "stocks remain expensive and earnings growth is poor."

According to LPL Financial, it has been nearly three years since the end of a period culminating in a double-digit drop for the S&P 500. Since 1980, only three periods have gone longer without such a decline.

Meanwhile, Deutsche Bank analyst Steven Zeng says his model shows the yield curve is now signaling a 55% chance of a U.S. recession within the next 12 months. That marks the highest probability generated by the model thus far.

Not to be outdone, Michael Feroli and the economists at JP Morgan say their model predicts chances of a recession before the end of 2017 are 67%, and the chances of a recession within three years are 92%.

Of course, we're also following a number of other measures that we believe support the conclusion that the bull market might be at an end, barring new rounds of central bank stimulus.

Below are some of the key indicators that we're monitoring.

Business Capital Investment: There's an obvious disconnect between so-called strong hiring and business investment. You can't have confidence in the employment numbers if business investment is at an all-time low.

According to a report by Standard & Poor's, capital expenditures across all industries fell 10% in 2015 and will continue declining, though at a slower pace, dropping to 4% in 2016 and to 2% in 2017.

Business Creation: Start-ups are an important component of a healthy economy, as they create many of the new jobs.

According to a Kauffman Foundation research report issued last year, the country's rate of new business creation, which peaked about a decade ago, plunged more than 30% during the Great Recession and has been slow to bounce back.

Even worse, the Kauffman report found that business deaths now outpace business births for the first time since researchers started collecting data in the late 1970s.

This is real cause for concern since young businesses account for nearly all net new jobs created in the U.S. "Older businesses, by comparison, tend to collectively shed from their payrolls almost as many workers as they add," the report said.

Job-Gain Averages: Barclays Chief U.S. Economist Michael Gapen said that marked drop-offs in payroll gains from a recovery's average typically presage recessions nine to 18 months later.

Monthly gains are still averaging just 147,000 the past three months and 172,000 so far this year, well below the 229,000 pace in 2015. Investors should be laser-focused on whether the trend is rising or falling.

Corporate Profits: Over the past few years, corporations have endured persistent declines in revenues, a disturbing trend that is finally eroding bottom lines, leading to what some have called a "profit recession."

According to S&P Capital I.Q., aggregate corporate earnings in the second quarter are down 5.5% from a year ago, for the fourth quarterly decline in a row.

The fact that profits are declining means post-recession cost-cutting (mainly through layoffs) is no longer supporting the bottom line.

Further, we know that firms have not been reinvesting in their businesses by spending or hiring, given all the cash idling on corporate balance sheets.

Gross Domestic Product (GDP): No matter how bulls or bears spin various indicators, you can't ignore the economy's big picture.

Indeed, U.S. GDP expanded by just 1.2% in the second quarter, prompting Deutsche bank analysts to day the Federal Reserve risks a "big policy error," if it hikes rates.

So if we get a sustained market selloff, it will be time to back up the truck and load up on utilities.

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