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3 Market Rally Risks

Lauren Lyster
Daily Ticker

It’s April 1st, which might be a good day to ask if the market has been playing a big April Fool’s joke on us with the 10% (or more) rally on the Dow (^DJI) and S&P 500 (^GSPC) we’ve seen over the last three months.

After all, the last three Aprils in a row brought us market peaks followed by 10% – 19% losses.

Related: April Showers: Another Springtime Correction Ahead?

Cullen Roche, founder of the San Diego-based financial consulting firm Orcam Financial Group and author of the Pragmatic Capitalism blog sat down with The Daily Ticker to explain what some of his favorite market indicators are telling him.

The first is reported to be Warren Buffett’s favorite valuation indicator, showing the market’s total market capitalization relative to Gross National Product (GNP). Roche says it’s a way of gauging the market’s current value relative to actual underlying output.

Roche tells The Daily Ticker that right now, for it’s third time in history, this indicator has breached the 100% level. The other two were in 1999 and 2007, when the measure ultimately went to 120% and 105% respectively (before the market went south).

The takeaway? We’re at an equilibrium point, according to Roche, but this is a good risk gauge going forward. In other words, if the measure gets higher, start to be concerned that asset prices are getting away from what the fundamentals can deliver.

The other measure is Roche’s Recession Indicator. According to Roche, it’s relatively low right now. He says this is important to understand because the worst market downturns tend to occur within in a recession.

Related: Beware the Ides of April But Don’t Expect Another ‘Spring Swoon’: Sozzi

So how concerned should investors be heading into April?

“I think that there is probably a moderately high risk of some sort of near-term sideways or negative market environment,” Roche says. “But given the long-term indicators [we’re discussing], if you take a more cyclical view of the market, I think you have to remain bullish within that longer-term view.”

Related: Dow 20,000 Is Coming in 2014 or Early 2015: James Altucher

Indicators aside, Roche acknowledges you have to consider the Federal Reserve’s $85 billion-per month bond buying and ZIRP policies – market elixirs helping to provide cheap liquidity, while low rates push investors into higher risk investments.

“The Fed has been very clear that they’re going to leave the punchbowl out and they want people to get sloppy drunk before they pull it away,” Roche says.

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