- Lance Roberts is warning that stock market indicators show fragile conditions.
- He expects a drop of up to 50% in the S&P 500 ahead.
- He also says “we are likely near a peak in the market.”
By a number of indicators, stocks are in a precarious position even as the major indexes sit at record highs. Valuations are at all-time-highs. So is the so-called Warren Buffett indicator, measuring total stock market capitalization to GDP. The ratio of household equity ownership to disposable personal income is hovering near all-time-highs, and “rivals every previous bubble in history,” Roberts wrote in a recent post.
Roberts, the chief investment strategist at RIA Advisors, a financial-planning firm with over $1 billion in assets under management, sees even less talked-about, under-the-radar indicators showing signs of over-extension.
For example, the CBOE Skew Index, which essentially measures how worried investors are that an unexpected event will derail markets, is at a record high level of 146. The closer the index, shown in orange below, is to 100, the less investors perceive risk. The higher it goes from 100, the higher risk they perceive.
Then there’s the Irrational Exuberance index from Bespoke. It shows that investors aren’t confident about current valuations, but still think — at record high levels — that stocks will be higher a year from now.
“In simplistic terms, investors are as bullish as they can get,” Roberts wrote in the post.
Staying with investor sentiment, Roberts, who warned of a stock bubble before the February and March 2020 crash, cited where he believes we are in the Sentiment Trader Sentiment Cycle: the enthusiasm stage. Criteria for this stage are high optimism, easy credit, rush of offerings, risky stocks outperforming, and stretched valuations.
“Currently, we are seeing every box checked,” Roberts wrote.
In a phone call with Insider on Friday, Roberts said that while it’s difficult to tell exactly when stocks will top, “we are likely near a peak in the market.”
What the catalyst would be is unknown, but it could be the Federal Reserve tapering asset purchases sooner than expected, Roberts said.
Once such a pullback does unfold, Roberts said he expects it to be of the magnitude of up to 50%. This is because of the principle of mean reversion. Because stocks are 25% above their two-year moving average, they will likely snap back to 25% below their two-year moving average before returning to the mean.
Roberts pointed to prior mean reversions like 2008 and 2000 as precedent.
Roberts’ views in context
Beyond a small chorus of typically bearish investors, most on Wall Street don’t see a pullback to the tune of 50% ahead.
But some banks have started to issue warnings of potential for meaningful corrections.
Goldman Sachs’ Chief US Equity Strategist David Kostin said a matter of days ago that if yields on 10-year Treasury notes quickly go to 2.5%, the S&P 500 could drop 18% from its current level of 4,352. Morgan Stanley’s Chief US Equity Strategist Mike Wilson, who called market corrections and rallies remarkably accurately in 2020, also said recently that he expects the S&P 500 to see a 10% correction at some point this year.
Most also agree that current valuations will mute index returns going forward.
Stocks, in a broad sense, are walking on thin ice. The number of indicators saying so continues to pile up. And as the Fed prepares to taper, and as rising inflation continues to worry investors, the best approach for some investors in the months ahead may be a cautious one.
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