Why it could be time to start heeding the warning signs

Global stocks were pushed to their post-crisis highs last week and US equities continued their uphill stomp to reach record territory. The bulls are outshouting the bears.

The S&P 500 index struck 1,893.1 on Wednesday last week, while the FTSE All World index rose 0.23 per cent to its highest level since the end of 2007 on the same day. At the time of writing, the Dow Jones Industrial Average hit an intra-day all-time high of 16,600.

I wasn’t a financial journalist during the last peak and subsequent deep trough in markets so it is hard for me to tell if the mood at the moment matches that of the one back in 2007. However, I have heard enough anecdotal “oh, before the crisis…”-type stories that allude to the environment. I think there are factors now that investors should be paying attention to ahead of what could be a brewing market correction.

Many of the gains in US markets have been made on the back of investor sentiment rather than companies registering significant levels of revenue growth. While even the more cautious fund managers I have spoken to don’t expect any huge negative earnings surprise in the US, few would predict double-digit numbers.

Didn’t people ignore ‘warning signs’ before the last major market falls? Bradley Gerrard

This week, star fund manager Anthony Bolton said the US was “flashing an amber light”. His words are perhaps a ‘strike’, to use baseball parlance, against the equity market bulls.

Investec Asset Management’s multi-asset guru Philip Saunders was equally sanguine this week claiming the “principle risk for markets is the continuing erosion of earnings forecasts”. He acknowledged earnings growth would have to fall “close to zero” to undermine valuations, but this is perhaps another strike.

In its quarterly outlook, Saxo Bank predicts the S&P 500 index will peak at roughly 1,900-1,950 and “then a 30 per cent correction”. The group notes equities are the “only asset not yet hurt by the changing economic cycle”. Strike three?

Another consideration is that markets appear to be rising in the face of political and economic upheaval. The International Monetary Fund has also warned of “years of slow and sub-par growth” yet markets keep on stampeding. Didn’t people ignore ‘warning signs’ before the last major market falls?

The likelihood of a correction appears to be growing. The S&P 500 index has been more than 400 days without a correction. Statistical anomaly or warning sign – you decide. If you have benefited from the large appreciation in markets during the past five years, maybe it is time to start listening to the bears – or give them more space in client portfolios.

Bradley Gerrard is news editor of Investment Adviser. John Kenchington is away