Three Factors That Suggest A Market Top May Be Close

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Both the Dow 30 (^DJI) and the S&P 500 (^GSPC) broke through important psychological barriers barriers today, with the Dow pushing past 26,000 and the S&P breaking 2,800. After reaching new all time highs though, equities quickly reversed with the CBOE Volatility Index (^Vix) responding by surging as much as 20%. Did we just see market top?

An argument could certainly be made that this is just a technical pullback off of the breakthrough of said psychological barriers. Resistance is usually strong at these widely publicized levels and it often takes equity markets two or three tries to break through. While we could see a brief pullback followed by another advance, other factors suggest that something more fundamentally bearish is at play here.

Here are three reasons why we may have either just seen the top, or if not, that market top is pretty close and new highs may not go very far.

Yield Curve and Interest Rates

Short term interest rates have been on a beeline higher since September, without much movement from the Federal Reserve on the effective federal funds rate, the overnight interest rates it directly controls. In other words, the Fed may be losing control of interest raets. Rates on the 2-year have risen especially steeply, up past 2% now from just 1.27% in September. That’s a move of 58% with only a 13% move in the federal funds rate from 1.15% to 1.3% over the same time period.

At the same time, interest rates on long term treasuries, both the 10-year and the 30-year, are rising much more slowly. Rates on the 10-year (^TNX) have climbed only half as fast as the 2-year yield, and 30-year (^TYX) yields have risen even more slowly, only 6% over the same time frame for an absolute move of just 16 basis points. The yield curve is shrinking and it is currently at its lowest point since before the financial crisis.

Every bear market and recession since 1977 has been preceded by a flat-to-negative yield curve. We aren’t there yet, but we’re getting close.

The Fed is Turning off The Money Spigots

The percent change of the money supply controlled by the Fed since September is growing at the slowest seasonally adjusted pace in the last 8 years. The amount of dollars in circulation according to the Fed is only up 4.1% over the last 3 months. Last year at this point in the year that same measure was up 5.7%, in 2016 4.7%, in 2015 4.3%, and in 2014 6.2%. This by itself may not lead to a fall, but put up against the fastest 1,000 point surge in the history of the Dow and the fact that over $600 billion has been tied up in the cryptocurrency markets, it spells trouble because there may not be enough dollars available to support stock prices at current levels.

The Return of Inflation and Possible Government Shutdown

Inflation expectations are now nearing 3%, and if this translates to actual inflation of 3%, Congress is going to start having a hard time paying all its bills. Higher consumer prices means less money available to bid up stock prices. Combine this with the increasing possibility of a government shutdown by Friday at midnight given the animosity towards President Donald Trump from political opponents, and you have a recipe for a severe market backlash by the beginning of next week from which recovery to new highs seems questionable at best.

 

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