Six reasons that the risk of a stock-market selloff is rising. Here's what investors should be doing.

By Jamie Chisholm

Many markets are priced for perfection, warns Longview Economics

Keeping an eye on Wall Street risks - which are on the rise.

Investors wary of the "cover curse" - where an individual's, a sports team's or a company's appearance on a magazine's front cover signals a peak - may be rather concerned that Nvidia's Jensen Huang is getting star treatment on the latest issue of the Economist.

Chris Watling, chief market strategist at the London-based research boutique Longview Economics, does not admit to using newsstand hyperbole as a market indicator. Just as well because in our call of the day Watling lays out six issues that are already causing him concern about a market selloff within the next one to four months.

The first problem is what he terms technical price behavior. "Price action has been poor in recent weeks," he says. "After an initial breakout in early August (from the S&P 500's May to July trading range), there has been an absence of confirmatory follow-through buying of the index."

Watling's commentary was published before the S&P 500's 1.1% rally on Thursday as bond yields pulled back, but his observations remain pertinent as the market is yet to break meaningfully above its mid-August high.

Another concern is that institutional and most retail investors are nearly fully exposed to stocks. Bank of America's fund-manager survey reported in August that institutional cash levels were at or near the lowest levels on record, Watling recalls. Meanwhile, the American Association of Individual Investors (which tends to represent older retail investors) and Charles Schwab say cash levels are also at/close to record lows. "The tiredness in this equity market likely, in part, reflects that 'all in' positioning amongst those investors," says Watling.

A third issue is that rising bond yields of late have squeezed equity valuations, making bonds increasingly attractive relative to stocks and bringing technical models close to a sell equities/buy bonds signal. The selloff in bonds is driven by fiscal concerns alongside strong economic growth and high inflation, both of which are heavily linked to the AI trade, according to Watling.

Consequently, "if the stock market pulls back inflation should recede, growth prospects dim and the Fed back away from hikes," he says. "All of which would make bonds more attractive." This may be compounded by current positioning, with fund managers currently holding their biggest underweight position in bonds, according to the Bank of America survey.

The next fear cited is that credit markets are "priced for perfection," according to Watling. For example, premiums on riskier corporate bonds - the extra yield investors demand versus safer government debt - were around the lowest on record this week.

Meanwhile, currency volatility is also at record lows, with a measure of implied volatility based on six major currency pairs this week touching 6.7%, one of its lowest levels in decades. "Low currency volatility is often a precursor to a pullback," observes Watling.

A fifth area of concern is that single-stock volatility (measured by the Cboe S&P 500 Constituent Volatility Index, or "VIXEQ") and S&P 500 SPX volatility (measured by the Cboe Volatility Index, or "VIX" VIX) have diverged of late. A relatively much higher VIXEQ suggests a lot of churning fear and greed action in individual equities that belies the calm of the broader stock market. "When these two measures have gapped apart (in the past), it's been a sign of underlying disruption (dislocation) in the equity market and often a signal of a forthcoming pullback," says Watling.

Instances of this can be seen in the chart below.

The sixth and final concern is that the earnings outlook today might be as good as it gets. Watling notes that 12-month-forward earnings-growth expectations for the S&P 500 are currently at 36% on a year-on-year basis. They've only been higher on three occasions: 42.8% in June 2021, in the midst of the pandemic tech boom; 37.2% in May 2010, as the global economy revived following the financial crisis; and 47.2% in October 1988, which partially reflected better comparisons from when earnings were marked lower following the market crash in 1987.

"Today's current +36.0%, therefore, is unlikely to remain at such high levels for long (especially given current economic circumstances are not as strong as in prior examples)," says Watling.

With all the above concerns in mind, Longview Economics is removing its overweight position in equities and going neutral on stocks. And it recommends an overweight position in bonds.

The markets

U.S. stock-indices SPX DJIA COMP are mixed at the opening bell on Wall Street as Treasury yields BX:TMUBMUSD10Y rise following stronger-than-expected jobs data. The dollar index DXY is up, as oil futures (CL.1) fall and gold futures (GC00) slide.

 
Key asset performance                                                Last       5d     1m      YTD     1y 
S&P 500                                                              7747.71    0.22%  0.49%   13.18%  19.16% 
Nasdaq Composite                                                     26,584.06  0.16%  0.89%   14.38%  22.46% 
10-year Treasury                                                     4.762      4.50   11.10   59.00   68.50 
Gold                                                                 4513.9     0.22%  2.56%   4.19%   24.02% 
Oil                                                                  90.81      8.83%  17.81%  58.18%  46.54% 
Data: MarketWatch. Treasury yields change expressed in basis points 

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The buzz

The U.S. economy added 162,000 jobs in August, much higher than forecasts of a 53,000 gain, though the unemployment rate remained at 4.1% as expected. July's job loss of 23,000 was revised to a gain of 21,000.

Norway's $2.3 trillion sovereign wealth fund is considering an overhaul of its government bond portfolio that could see it slash holdings of U.S. Treasurys by about $80 billion, according to the Financial Times.

Tesla shares (TSLA) are giving up a chunk of the previous session's gains after the company held a closed event in Austin, Texas on Thursday to promote its Cybercab.

Volkswagen's stock (XE:VOW) is jumping in Frankfurt after the German car manufacturer said it may shed another 50,000 jobs as it battles competition from China and U.S. tariffs.

Shares of Lululemon (LULU) are diving after the yoga-wear company delivered another poorly received set of results. Michael Burry, trader of "The Big Short" fame, said Lululemon was his biggest holding.

U.S. markets will be closed on Monday for Labor Day.

Wall Street is betting on Fed Chair Kevin Warsh to keep a manic bond market from unraveling.

The chart

The U.S. trade balance widened substantially in July to -$88.6 billion, due to both a decline in exports and a rise in imports, observes Veronica Clark at Citigroup. "While strong imports mechanically will weigh on GDP growth in Q3, another large increase in imports of computers and electronics suggests another substantial boost to growth from equipment investment related to the AI-buildout," she says.

Top tickers

These were the most active stock-market ticker symbols on MarketWatch as of 6 a.m. Eastern.

 
Ticker symbol  Security name 
NVDA           Nvidia 
TSLA           Tesla 
GME            GameStop 
AMC            AMC Entertainment 
MU             Micron Technology 
AAPL           Apple 
AMD            Advanced Micro Devices 
PLTR           Palantir Technologies 
AVGO           Broadcom 
META           Meta Platforms 

Scientists studying cockroach milk and nose blowing are winners of Ig Nobel prizes.

-Jamie Chisholm

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09-04-26 0930ET