CrossCurrents and Rising Risks

10/13/2016 9:00 am EST

Focus: STOCKS

Alan Newman

Founder, Crosscurrents Publications, LLC

For months, we have seen so many negative divergences of all kinds that one wonders what it will take for the huge decline that we foresee, states Alan Newman, editor of CrossCurrents.

Valuation measures are at ridiculous extremes. The bull market has been held together for the worst of all reasons—the acceptance of continued increases in the amount of risk institutions are willing to bear.

At the same time, Moody’s has stated they examined 124 pension plans, “...finding the group was short by $337 billion at the end of 2014.

While strong investment returns helped boost plan assets 4.5% to $302 billion in 2014, obligations rose 5% to $639 billion.”

Rising obligations are forcing pensions to take on more risk for higher returns. There is no better recipe for disaster.

It happened into the March 2000 mania peak as pensions had to compete for higher returns, taking on the most fantastic risks since 1929.

While many pensions traded outside of equity mutual funds, the same principle was in effect. If you carried cash, performance became compromised.

For this reason, mutual fund cash levels fell to only 4% of assets, tying a 28-year-old record.

They easily broke the record just before the 2007 peak, and cash levels fell to 3.5% of assets. In June 2015, cash levels fell to yet another record of 3.2%, which was tied this July.

We monitor the Dow Industrial average's 5% regression line — a line that increases at a constant 5% rate. Over the last 119 years, the Dow Industrials have gained at exactly 4.98% annually, suggesting this 5% regression list is valid.

We used this line in the past to forecast bear markets and we’re using it again today. At the very least, we expect a return to the line, which stands today at Dow 14,308 and currently rises at about 13.5 points every week.

Meanwhile, the fear index, or VIX, is still way too low, indicating little fear. Everyone is in for the ride. No one is looking over their shoulder.

Mutual funds are sporting the lowest levels of cash-to-assets of all time, margin debt remains over 2.5% of GDP and valuation measures are completely out of whack.

It’s the perfect scenario for the perfect storm. An accident waiting to happen. A completely bizarre environment, very much like March 2000 and October 2007. Those two did not end well.

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By Alan Newman, Editor of CrossCurrents

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