Recently a little-followed economic index flashed a warning sign for equity prices. And I wanted to point it out to you today given the general sense of bullishness in the U.S. markets right now.
The Citi Economic Surprise Index (CESI) is an index that measures whether recent economic data is surprising positively or negatively versus expectations.
Recently that index crossed below the zero line. And historically that has not been good for the stock market over the subsequent few months.
Six of the last seven times the CESI has moved below zero, stocks declined over the following three–month period. The average maximum upside in stocks during that time was 1 percent, while the average decline was 8 percent.
That period includes the financial crisis. But looking more recently, as shown in the chart above, the CESI last broke below zero on 4/25/12, and the S&P 500 fell 3.8 percent over the next three months.
What’s more, the inherent logic behind this makes sense. Here’s why …
By measuring whether the economic data meets estimates, rather than whether it’s growing or contracting, you are seeing if the economy is meeting investors’ perception about the future. And as that perception changes from positive to negative, investors will “de-risk” their portfolios and move into cash.
This is just one indicator. But its recent predictive ability shouldn’t be ignored. I’m not sure this marks the near-term top of the market. But at the very least it should make you think twice before buying domestic stocks at their current, elevated prices.
No market goes up or down in a straight line, regardless of the underlying fundamentals — the Fed money printing being chief among them. And a correction or pause is needed at these levels.
It’s the Opposite Story for Europe
However, while the U.S. CESI has broken below zero, the European CESI continues to rocket higher, reflecting the green shoots appearing in the European economy.
Click the chart for a larger view.
That underscores the significant outperformance recently of international equities versus domestics — something I’ve been alerting Money and Markets readers to with an early focus on Japan, and now spreading to Europe.
And despite the weakness in European shares earlier this week centered on political concerns, the bottom line is that the European and global economy is showing signs of life.
One way you can potentially profit from a correction or pause in the U.S. market is via the ProShares Short Russell2000 (RWM). This ETF is meant to rise 1 percent for every 1 percent decline in small-cap U.S. stocks, which is the area of the market that should decline the most if a correction begins.