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3 major warning signs may mean danger ahead for the stock market

Brian Sozzi
Editor-at-Large

Believe it or not, 2.4% is how far the S&P 500 (^GSPC) stands from its all-time highs. Don’t think everything is fine and dandy out there in the markets, however — the minefields are set to blow up investors at some point before year end.

The triggers for those bombs are numerous.

It could be stalled trade talks between the U.S. and China this week. More third quarter earnings reports later this month similar to the disaster from FedEx (FDX) a few weeks ago would piss off investors holding out hope the Federal Reserve’s low interest rates could save their rears. Another three-week stretch of souring reads on the health of the U.S. economy not unlike the manufacturing prints that freaked out the bulls last week is also rather probable.

“We need to see some of these [economic] numbers get better,” Belpointe Asset Management Chief strategist David Nelson said on Yahoo Finance’s The First Trade. Nelson is concerned that amidst so much economic uncertainty, S&P 500 profit estimates remain too high. Very well-served haircuts to those profit forecasts by Wall Street may soon pressure stock valuations.

Unsurprisingly, certain forward-looking market indicators are flashing danger ahead for investors. Here are three specific measures, with an assist going to data from Yahoo Finance Premium.

FAANG has died

Despite ongoing low interest rates from the Fed, investors are no longer leveraging up on that cheap money to buy the once popular — always insanely valued — FAANG stocks. Facebook (FB), Amazon (AMZN) and Netflix (NFLX) have shed an average of 15.6% over the past three months, grossly underperforming the Nasdaq Composite (down 1.4%), S&P 500 (down 1%) and Dow Jones Industrial Average (down 1%).

The NYSE FANG+ Index (^NYFANG) — which includes the performance of other hot momentum tech names such as Tesla (TSLA) and Nvidia (NVDA) — has flat-lined over the past three months.

Facebook, Amazon, Netflix and Google logos are seen in this combination photo from Reuters files. REUTERS/File Photos

Apple (AAPL) and Alphabet (GOOG) have been the saving grace for FAANG investors — up 13.5% and 8.5% in three months, respectively, likely due to each’s more defensive properties compared to their peers in the investing acronym.

Instead, investors continue to be upbeat on defensive stocks across the health care and consumer staple complexes. Investors appear to appreciate the dividend yields (especially stacked up against the low 10-year Treasury yield) and relative operational stability of defensives than the FAANG momentum trades.

“Investors we speak to are not yet willing to rotate towards cyclicals and away from secular growth and the defensive areas. The rotation has been made increasingly more difficult due to the weaker economic data,” strategists at Jefferies wrote in a note to clients.

Telling as to the future direction of stocks and the U.S. economy, no?

Recession risk climbs

Recession talk on Wall Street has begun to resurface after going quiet during the market’s September rally. A few bad manufacturing and consumer confidence prints and a renewed downtrend in the safe-haven 10-year Treasury yield will do that, after all.

The risk of a recession has now spiked noticeably in one closely watched market gauge. The New York Fed’s recession probability index — which uses the yield curve to create its output — puts the chances of a U.S. recession within the next 12 months at about 40%. That marks the highest level of the bull market that kicked off in 2009.

Dow Transports continue to suck wind

The Dow Jones Transportation Average Index (^DJT) is often used as a proxy on the health of the global economy. Weakness in the transports — comprised of the railroads and airlines and the like — often suggests market participants are losing confidence in the global economic outlook.

And if this old school market indicator is right, then the U.S. economy will be barely growing in the first half of 2020 and stocks deserve a haircut right now. The Dow Transports have fallen about 8% in the past six months — 4% in the last three months alone — and have obviously lagged the broader market indices.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow him on Twitter @BrianSozzi

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