Why it's time to get cautious about stocks

Early market bull James Stack hasn't recommended selling stocks just yet, but he's keeping an eye on the exits. 'We're in the latter innings of this ball game,' he says.

By MSN Money Partner Jan 17, 2014 4:46PM
Image: Bull (© Photographers Choice RF/SuperStock)By Howard Gold, MarketWatch

One of the first independent advisers to call the current bull market is now raising a cautionary flag.

James Stack, president of Stack Investment Research, warns subscribers to his newsletter, InvesTech Research, that the five-year-old bull is aging rapidly. 

Although he hasn't recommended selling stocks just yet, he says risk is rising and has one eye on the exits.

Attention must be paid. Early in his career, Stack, along with the late, great Marty Zweig, predicted the 1987 stock market crash. Twenty years later, in August 2007, he wrote: "We are taking steps to reduce exposure as warning flags increase."

But unlike some perma-bears who never know when to quit, Stack turned bullish again in early 2009. I remember a conversation at a conference in Orlando that February in which he made the case for a new bull market while I was still very doom-and-gloom. It was one of those moments in life (oh, yes, I've had a few) when I should have kept my mouth shut and listened -- and then bought stocks.

Since then, the Standard & Poor's 500 Index ($INX) has rallied 170 percent. Over the past 15 years ending in December, an InvesTech model portfolio tracked by the Hulbert Financial Digest has gained 8.3 percent annually, easily outperforming the Wilshire 5000's (WINDX)  5.4 percent yearly returns -- and with a third less risk.

In a telephone interview from his headquarters in idyllic Whitefish, Mont., last week, Stack pointed out that 2013's nearly 30 percent gain in the S&P was the 10th largest in the last 85 years.

"I don't think anyone who was positive on the outlook for 2013 could have expected the size of the advance we've seen," he told me.

Meanwhile, he said, economic trends are "all entering 2014 in strong fashion," presenting "little probability of a recession in the first half or three quarters of the year."

But, he wrote in his most recent newsletter, "a strong economic outlook doesn’t negate the possibility of a bear market. The stock market leads the economy, and market peaks precede the start of recession by 5.5 months on average."

All in all, he told me, "both macroeconomic and technical [indicators] still support more bull market highs in 2014." But he's getting worried.

"Technically we're about 15 percent above long-term historical valuations," he said. The S&P 500 trades at 19 times trailing-12-month earnings, vs. an average of 17 times trailing earnings.

And then there's the calendar, particularly the four-year presidential cycle, which is of great interest to technicians and market historians. "The middle two quarters of a midterm election year are historically the weakest," he said.

Stack's research shows that since 1940, mid-term election years have averaged a modest 5.7 percent gain, but they've been characterized by greater volatility.

On average, the S&P 500 has declined 2.2 percent in the second quarter of a mid-term year and 0.6 percent in the third quarter, with losses roughly half the time in both. The fourth quarter of a midterm election year, however, tends to be strong.

That's one reason Stack believes "the odds of a significant market correction are quite high this year, and it's likely to occur in the second or third quarter."

That puts him in line with a couple of the smart bulls I wrote about last week who expect a big correction in 2014.

"It's been over two years since the last 10 percent correction," Stack told me. "We're certainly due for that."

And maybe even more than a correction. Although Stack repeated one of his favorite maxims, "bull markets don't die of old age," he also said, "the difficulty is that it is an aging bull market."

"Risk increases as a bull market ages," he wrote last week. "So do economic and monetary imbalances. . . and the potential for surprises."

The 15 bull markets over the past 82 years had an average duration of 3.8 years, he reported. This one turns five in March. "So not only is the current bull market a full year longer than the norm, it is about to become the fourth-longest bull market since 1932," he wrote. "If that doesn't make you nervous, it should."

Stack isn't reducing his recommended stock exposure, but he is watching the economy and some technical indicators like the advance/decline line (which tracks changes in the number of stocks with price gains vs. the number with declining prices) and his own proprietary index of bellwether (market-leading) stocks.

Recently that indicator has put out some cautionary signs, too, by "moving sideways over the last six months while the market has been hitting new highs."

"It's not the kind of divergence we've seen in 2000 and 2007," he told me, but it’s divergence nonetheless.

So, what does his gut tell him?

"My gut tells me we're in the latter innings of this ball game," he said in our interview. And he had a clear warning for investors who've been out of the market until now and are thinking of jumping into stocks again.

"Don't increase your exposure or increase your risk at this point in the bull market," he said. "The last thing you want to do is take a position that's been mostly in cash and invest aggressively."

I agree. Though I think the market is likely to hit new highs this year, I also think a big correction is coming and don’t know how long this bull will last. So, I'm sticking with my 50 percent allocation in equities but I'm not adding a penny more. And neither should you.

More from MarketWatch

Jan 17, 2014 10:46PM

First... if your philosophy has been-- anything I do makes money... by all means go all-in now. You'll be rewarded for your hollow arrogance with-- game tokens.

Crazy Cat-- when your post is an anticipation of my post-- you're toast. I post less now because I'm out raking in profits as your markets fall apart. Two weeks ago I raised my prices and sales went up. You're an emotional investor who doesn't know an asset from a hole in the ground.

Now... where we are at, The 5 weeks of Christmas should have been a boon for online retailers but brick and mortar had a game plan... give good stuff away for less than we paid for it! The reward is a free fall like Best Buy. There's a bunch more standing in line waiting for their thrashing. Everything is at a standstill now-- the working are buried in bureaucracy, the under and unemployed are tapping out the last of their reserves. Home sales are not good. Those who can afford to buy, buy cheap. Quality housing is so badly stagnated that comparable sales are rare and exceed the time they qualify as such. Jobs are dead. The idiots who whine about not being able to find talent should read their own postings-- a digital analyst is an editor. Anyone schooled before the text generation can do it. Selling isn't huckstering, it's creating awareness that leads people to make intelligent decisions. Banking is a complete bust. Wells surpasses Chase simply because JPM is being pounded with lawsuits. No one with a brain actually wants to be hustled by Wells, so being the best of the worst isn't worth praise.

We're going down, folks. The bottom comes hard with this much lard attached to our azz.

Jan 17, 2014 9:06PM
stocks have done so well over the past five years that almost everyone is bullish these days, so whenever I talk about the possibility of a market crash, some people just dismiss my idea. They believe that the indexes are a surefire way to win in the market

I don't see any indicators saying that stocks will definitely crash. but if the spectacular run-up of the last few years has given you too much equity exposure, then this would probably be a smart time to consider re-balancing.
Jan 17, 2014 5:31PM
hmmm....   many earnings misses, downgraded guidance, money printing ending, JCP laying off 2000, Intel 6000 over the last 3 days...  consumer confidence down, a really bad jobs report....

nah, I'd say through caution to the wind and BUY...  if you are crazy.   Be very cautious.  Obamanomics is still in place.  Obamacare and Obama's tax hikes should might send us into another recession.  A double dip is very possible as interest rates increase.
Jan 17, 2014 9:35PM

Tapering afoot...

Heard that Margins are at very high levels..

Several companies missing only by penny or pennies; Get beat up.

Guidance fair, but not earth shaking for first quarter or half.

But many equities at or near all time highs, most at 52 week-3 year best.

All Indices, breaking new ground.

Others indicators...50/50..... good/bad.

Good quality companies, with decent dividends, may be the best choices next few months. 

Jan 18, 2014 11:29AM

Didn't realize S&P gained 30% this past year...??

Also thought the Trailing P/E was about 16-17 not 19, guess I should pay closer attention.


Bull Markets are born on pessimism,

Grown on skepticism,

Mature on optimism,

And die on Euphoria..

                        John Templeton

Jan 18, 2014 2:38PM
Anyone hearing the commercials for Goldman Sachs' 10,000 Small Businesses Initiative? They will help you set-up a small business and then "consult" you right after you sign a very long small print legalese contract. No one on the "Board of Trustees" actually ran or runs a small business. Goldman Sachs has a threshold for clients so they don't do business with small businesses on a banking level either. Goldman Sachs is a component of the Dow Industrial ... but it's bank... that has no branches... and doesn't deal with 95% of Americans... but it wants to help you and I with our Free Enterprises. Not.  
Jan 18, 2014 12:25AM
Jan 19, 2014 12:22PM

The market is going up because we are in a global market, We don't depend on just the USA, we buy China, Europe, Brazil, Russia etc.

Also where are you going to put your cash? in a bank? under the mattress (same thing, the bank's a little better as you're protected from fires).

I will really get worried when bond and interest rates start to go up and our government becomes more responsible.


Jan 19, 2014 5:49PM

Don't take issue, with you too often Active...but...

But yes, General Electric (GE) was down a bunch back in the mini-crash; Mostly due to their Financial Arm connection as we know...

It may still be down now 50%, which gives us hope for more solid upside, they have made some changes and rearrangement of their business model...They manufacture everything from sewing needles to rocket engines Worldwide...Heavy into Energy now and Defense also, with 300-400,000 employees...And the "only" original listing still on the DOW..

Since taking positions even with DC'Averaging 'up some', we have "doubled", that's an average of about 20% gain per year, since the downside; NOT including the dividends of 3.5-4 %, which I forecast to be raised in the near future, and not including possible appreciation...

We are Long on GE...Real Long, unless we might need some cash.

Oh yeah Waste Management, you are correct....A "Steady Eddy" that pays about 4% div a year.

I even discussed this with our "Local Pussy Cat", Classic Lady before we started accumulating.

Think it's headquartered out West or Texas...?

The appreciation has been about 50% so far, and I like collecting that decent dividend that's pretty damn safe....IMO.....Stay safe.  

Jan 17, 2014 9:57PM
Maybe after the market crashes, we can get something else this country is due, a good revival.  There are no atheists in foxholes, and those who struggle to survive may finally be humbled and cry out to God for relief.  At least the sane ones, anyway. He may just surprise you by how much He has to give.  "He is no fool who gives up what he can't keep to gain that which he can't lose."  Quote.
Jan 18, 2014 2:32PM
Standing up for your home town. Consider this, one bank product... the "sweep" let's all of those BIG out-of-town headquartered businesses we're forced to deal with, to have their day's deposits whisked away to someplace else. Your town, my town, our towns nationwide are barely alive now because the sum total revenues come from the near-poverty pay of the folks forced to work in and rely on those places. THINK about the damage just Wal-Mart has done. There's a Federal lawsuit filed now about unfair wage manipulation. That "unfairness" translates into stagnation in towns all across America.
Anybody see JP Morgan Chase Manhattan Bank One Washington Mutual et al... show up in YOUR hometown and fork out cash to restore a Main Street and all the businesses put out of business by that Wal-Mart on the highway exit? We don't need charities. We ARE a charity, because it's easier for obscene wealth to give anonymously conveniently, then to address the messes they've caused with this psycho-sociopath crap we endure. 
WAKE UP, AMERICA... our forefathers would vomit on what we've become. It's time to end dumb alumni dominance, old wealth omnipotence and grubbers. If QE doesn't help you or me, why is it okay to give it to the top 5% wage-earners in America. Are they... charities or terrorists? 
Jan 19, 2014 9:21PM
NextTimeUp posted,
"We have been an imperialistic nation for most of our existence. We have raped and plundered the world for increased profits. Now the world organization demands we give back. And we are experiencing that pain today and will until many Americans are lowered to the rest of the world level"

This is my response:
Imperialism has been the case for Civilization since the very start. Rome liberated Gold and other resources from Europe. Ditto for Europe. As far as the World Organizations demanding back what was stolen from Gold and Silver to literally everything else, I really haven't seen that. What I do see, the same Global Elitist seeing Wealth beyond their wildest dreams while the Global Population at large is seeing unprecedented poverty in Modern Times.

Free trade is being promoted as a tide that lifts all boats when it's real intent all along has been a Global Right to Work for Less. Meanwhile the 1% have created Unions which go by the Name of Boardrooms. They vote on giving themselves massive Wage increases while colluding to decrease wages and benefits for everyone else.

The World has seen a massive transfer of Wealth to the already SuperRich. When the working poor and Fading Middle-Class demand that it stops, they are charged with Class Warfare. Meanwhile, the Class Warfare against the working poor and fading Middle-Class continues. Meanwhile the massive Wealth transfer off the Backs of the Working Poor and fading Middle-Class continues.
Jan 20, 2014 1:16PM
Stack could be right, though no one can predict the future. It's probably safe to assume that any bull market that's gone on this long could be due for a substantial pullback. So a reasonable approach would be to prepare by holding a good amount of cash so you can buy on the dip. I've got about 15% of my $460,000 portfolio in cash right now.
Jan 19, 2014 5:11PM

Trolling-George, Yes I agree! Nothing like a Big multi-national conglomerate and a Trash hauler for a good basis in investments; We hold long on both..

Sprinkle in other energy and pipelines, with selected retail and health/medical; You can get or have a real good diversified mix for our ongoing recovery and baby booming, that some don't feel exist..

First off we have to believe and not fear the unknown...It's always been there, how it is handled is what makes the difference ...

Good History Lesson and Facts ACTIVE, keep the doomsayers in line...Smoke but not fire.

I don't appreciate twisting and deflecting that we sometimes get on here...

Wait until they have to deal with Hillary; This could get exciting...

Keep up the Good Fight, but we don't need to read it twice,VL.

Good investing in 2014.....and as you remind, Stay Safe.

Jan 18, 2014 11:32AM
RE-TOG:The people always wanting a market crash are the ones that missed the bull market of the last few years.Bitterness is tough for them to handle.

Speaking of mid terms, I guarentee you that if the Republicans take the House and Senate, obama WILL have the Fed stop their activity. Markets will go down, people will pull out, and all the blame will be on the Repubs since they have more power.

Chicago politics baby!

Jan 20, 2014 9:58AM
Jan 18, 2014 9:22PM
Gdm....I'm glad I went to the Casino....Old Geezie, is Soylent Green..
Jan 18, 2014 3:20PM
Stop trying to guess. If you are out, or get out, you lose. It's really as simple as that. You have to be in the market to reap the upside. The time to get out is when the major averages drop 7 or 8%, because after that, you have no idea where the bottom is. Until then, sit tight, or you may lose another 10,12,15% upside this year alone.
Jan 18, 2014 9:27PM

With GE and WM what go wrong? big dividends, besides, everyone uses energy and produces trash. Throw in some ZBB in case electric cars and storage batteries boom?  DVN for oil, "poor choice but"

See what happens

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