10 charts show why market may be ripe for a correction

As the U.S. stock market rallies to fresh record highs every few days, most investors will be hard-pressed to find incentives to sell out of the market. Yet, Bank of America Merrill Lynch has decided to take on the role of Wall Street’s Debbie Downer, warning of an impending correction. CLICK LINK AT BOTTOM TO SEE PICTURES OF CHARTS.

Savita Subramanian, equity and quantitative strategist at Bank of America, has been the consistent voice of caution this year even as the S&P 500 SPX, -0.14% is poised for a six-month winning streak — the longest since 2013. On Tuesday, she cited 10 reasons why she believes the market is ripe for a selloff, framing her bearish outlook in a series of charts.

1. Valuation: As of end of July, the S&P 500 was overvalued pretty much on all fronts, according to Subramanian. “U.S. stocks look expensive versus history on most metrics,” she said.

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2. Positioning: A decline in short-interest-to-float ratio suggests that sentiment is increasingly bullish, which some view as a contrarian indicator.

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3. Fiscal stimulus: Expectations of fiscal support for the economy is hovering at levels not seen since the height of the Great Recession, but Subramanian believes investors betting on additional fiscal stimulus will be disappointed.

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4. Economic surprises: The incidences of economic data beating on the upside have started to wane, which is expected to drag on market sentiment

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5. Corporates: Earnings are not expected to recover anytime soon, while sales growth remains subdued, slipping to a three-year low. Many analysts believe the stock market will not be able to sustain its upside momentum if earnings do not recover.

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6. China: Concerns about the world’s second-largest economy have abated amid signs of stability, but the country’s manufacturing sector has started to contract again, prompting worries of further economic slowdown.

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7. Leverage: Debt at S&P 500 companies is rising, while creditors have been tightening their lending standards for the fourth consecutive quarter.

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8. Elections: Political uncertainties are expected to mount ahead of the November presidential election and dampen corporate investment, a key engine for economic growth.

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9. The Federal Reserve: The market may not be reading the Fed accurately. “BofAML interest rate forecasts imply a far more aggressive pace of Fed tightening than is currently priced into the market,” said Subramanian. The CME Group’s FedWatch tool, which tracks Wall Street’s expectations for a Fed interest-rate hike, indicated that the market was pricing in a 24% probability of a rate increase in September, and a 44.1% probability in December.

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10. September slump: History is working against the market. September is typically the weakest month of the year; since 1928, the S&P 500 has dropped in September 56% of the time.




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