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David Rosenberg: Top 10 reasons to be cautious on equities

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave

Deborah Baic/The Globe and Mail

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. For a free two-week trial, click here and use promo code Signposts.

Here are my 10 reasons to be cautious on equity markets right now.

Valuations are stretched

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Trailing and forward price-to-earnings multiples are now in the top quintiles historically and the most expensive in 15 years.

Only in 1929 and the "Dotcom" bubble has the cyclically-adjusted multiple (CAPE) been as high as the case today.

We are heading into the ninth year in the cycle and have logged an epic 250-per-cent surge in the process. As retail investors now plow in to this market in the late innings, one could legitimately ask what it is they could possibly know that corporate insiders do not, considering the latter have been selling their company's stock this year at a pace not seen since the data began to be published in 1988.

Extended leverage

U.S. margin debt has surged at a 27-per-cent annual rate since immediately prior to the election to stand at $513-billion, the highest level on record (eclipsing the high from April 2015).

Retail inflows

After an eight-year hiatus ($200-billion of net outflows), private clients have thrown in the towel and plowed nearly $80-billion into mutual funds and ETFs since the November election.

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Remember Bob Farrell's Rule No. 5: "The public buys the most at the top and the least at the bottom".

Narrowing leadership

For the past four sessions, we have seen more new 52-week lows than new highs (the longest streak since Nov. 4) — a technical sign of a toppy market.

Moreover, the Russell 2000 index is now flat for the year and off 4 per cent from the high — again, we know from history that the generals tend to follow the privates.

Tack on the fact that the S&P 500 recently traded as much as 10 per cent above the 200-day moving average, and we have a market ripe for a near-term correction.

Complacency abounds

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From a VIX of 11.9 to nearly 60-per-cent Bulls in the Investors Intelligence poll — though this has begun to roll off its highs in a sign of the "smart money" beginning to take profits.

The S&P 500 has gone 57 days without so much as a 1-per-cent intraday swing, something we have not seen in at least 35 years. The proverbial calm before the storm.

The Fed is in play

The front-end Treasury yields are rising discernibly — the two-year T-note yield has gapped up to nearly 1.4 per cent and futures market is in the process of pricing in an extra two rate hikes after the likely March tightening (the overnight index swaps market currently has priced in 70 basis points of tightening by year end).

The Fed has met its twin objectives and the fed funds rate consistent with that is 3 per cent, not the 0.75 per cent currently.

By the time the Fed reaches that level, the yield curve will likely have inverted long before and that's when the clouds will come rolling in.

This could be next year's story, which means a forward-looking market begins to discount this prospect sometime later this year.

Inflation pickup

Cyclical price pressures are showing through, with the core PCE inflation rate at a 30-month high of 1.738 per cent year over year.

As was the case in 1990, 2000 or 2007, this likely is not sustainable, but is a classic late-game signpost nonetheless.

All one needs to see is the latest blow-off in the commodity complex, which is now on pause, to notice how late cycle we are. Remember what oil did, for example, in 2008?

Lofty expectations

The survey data are at extremely high levels at a time when actual economic growth is running barely above a 1% annual rate.

Gaps like this, once again, are classic near-end-of-cycle developments.

The prospect of there being huge disappointment over the pace of policy change in Washington is also very high.

Over-ownership

While households were not net buyers of equities until very recently, the near-quadrupling in the stock market has still boosted their exposure to a 21.1-per-cent share of total assets. Only five times in the past 16 years has the share been this high or higher — this is 42% above the norm.

Frothy credit markets

Bonds lead stocks, just know that. And the risk-premium on U.S. high-yield corporate bonds very recently approached lows for the cycle at a super-tight 335 basis points.

However, they now are widening again, and with the overall narrowing path of the Treasury curve, this is well worth monitoring for those equity investors who are still long this market.

Nobody ever lost money by booking a profit, especially for a cycle that is now heading into year number nine.

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About the Author
David Rosenberg

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. More

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