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Equities Beware: Bearish Indicators on the Rise

NEW YORK ( TheStreet) -- Bearish investors pointed to signs sentiment is beginning to deteriorate, as markets continue rising in the face of geopolitical risks, mixed economic data and lackluster earnings forecasts.

Many traders pointed to the lagging performance among listed financials -- the largest industry component in the S&P 500 -- as cause for concern. Financial institutions are adjusting to a higher rate backdrop, which may hurt in the short term but should ultimately benefit them as the economy recovers. As a stronger economy boosts bank profits, a lagging banks sector calls into question the sustainability of a market rally. When the market rallied in 2013, for example, the performance of financials outstripped risk-adverse sectors such as utilities. But the returns of both sectors have been on-par the past six months, suggesting a more cautious approach by investors and reallocation away from riskier industries. As per the chart below, financials are lagging the broader market.

 

Another potential red flag: Fewer stocks are hitting their all-time highs. This suggests last year's rally is running out of steam, with 84 stocks hitting new highs so far this month against 229 for the same period last year. Global markets are also taking a cautious view as the S&P continues its ascent. Key European stocks, as represented by the EuroStoxx 50, have failed to reach their January highs again, rattled by factors such as geopolitical uncertainty in Ukraine. On the flipside, some argue that the outperformance of the S&P over European stocks is justified, given the relatively stronger economic and earnings outlook for the world's largest economy. Still, emerging market debt woes are seen as a lurking risk to equity sentiment everywhere as a wind back of global stimulus this year prompts the ongoing reallocation of funds away from riskier economies.

 

Broader risk barometers in the form of the gold price and Aussie dollar also point to investor caution. The yellow metal has rallied hard for the year to date, fueled by geopolitical and emerging market uncertainty. The prospect of en masse debt problems in China and questions around its growth composition are adding to fears. Similarly, risk currencies such as the Aussie have moved sideways for the year to date, having shed 6% over the past six months.

 

Bulls shrug off these indicators, pointing to the ongoing outperformance of small-cap stocks -- as represented by the Russell 2000 -- as evidence the domestic economy recovery is well in train. Similarly, Dow transports are also outstripping the broader market, while the wind-back of stimulus demonstrates the Federal Reserve's belief that equity gains can continue without support. Few expect a drastic correction this year, given the relative health of the U.S. economy and corporate outlooks relative to developed nations across the eurozone and Japan. But as U.S. stocks enter their sixth year of a bull market, bearish indicators are beginning to cause unease.

-- Written by Jane Searle in New York

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