Bearish bets against the S&P 500 Index (SPX) are increasing rapidly, and that's just one of five big signs that 2019 is shaping up to be a rough one for stocks, if mounting fears among investors are realized. "The market tensions we saw during this quarter were not an isolated event," according to Claudio Borio, head of the Monetary and Economic Department at the Bank for International Settlements (BIS), as quoted by Business Insider.
The five danger signs listed below represent a startling reversal for investors who recently were eager to buy stocks regardless of price and whether or not they had been falling.
5 Signs of a Troubled Market:
- Soaring short interest on the S&P 500
- Near-record weekly outflow from U.S. equities
- Record weekly outflow from global stocks
- Small cap stocks in a bear market
- BIS sees more turbulence ahead in 2019
Significance For Investors
The first three indicators above suggest that worried investors are fleeing stocks, hedging against a market downdraft, or seeking to profit from a market collapse. Short interest in the SPDR S&P 500 Trust ETF (SPY) is near 6% of the shares outstanding, roughly double the level that persisted for much of 2018, per data from IHS Markit cited by Business Insider.
Investors took a net $27.6 billion out of U.S. equities in the week ending Dec. 12, per analysis by Bank of America Merrill Lynch reported by Business Insider. This was the second-highest weekly withdrawal ever. During the same week, a record $39 billion was removed from stocks worldwide.
The Russell 2000 Index (RUT), the leading benchmark for small cap stocks in the U.S., has dropped by more than 20% from its record high close on Aug. 31, thus putting it in a bear market. Moreover, the Russell has given up all gains since Aug. 2017, and reached a recent bottom that represented a loss of over 10% year-to-date, more than double the decline in the S&P 500 during the same period.
Small cap stocks tend to be riskier than the large cap equities in the S&P 500 for several reasons, per Barron's: less pricing power with customers, less bargaining power with suppliers, less diversification, more leverage, and less likely to be profitable. The same article notes that investors tend to flee small caps "late in a cycle when rates are rising and the economy looks set to slow." As a result, the bear market in small caps may be an indicator of further declines in other categories of stocks. A number of major stock indexes around the world already have suffered big drops, as detailed in another Investopedia article.
Finally, observations from the BIS carry great weight, since it is a key cog in the international financial system, often called the "central bank for central banks." BIS official Claudio Borio, in addition to the quote above, sees "mixed signals from the global economy...tightening of financial conditions...protracted trade tensions...heightened political uncertainty" as key issues going into 2019.
Even if trade conflicts abate, and world economic growth does not decelerate as quickly as the pessimists fear, the large vote of no confidence in equities now being registered by investors may bode ill for gains in 2019.
Paul Ciana, the chief global FICC (fixed income, currencies and commodities) technical strategist at Bank of America Merrill Lynch, advises investors to short the S&P 500 and buy the U.S. dollar, per CNBC. He presented a chart showing that the ratio of the value of the dollar to the S&P 500 has trended downwards since the early 1990s. Previous bottoms in 2000 (before the dotcom crash), 2008 (during the financial crisis) and 2014-15 were followed by a rising dollar and a tumbling S&P 500, he notes.