These Three Factors Are Increasing Stock Market Risks– Mike Swanson

Some huge things are starting to happen in the financial markets and risks are growing.

There are two factors that are helping to create the risks and one big factor that you need to keep your eye on.

At the moment the market is topping and trying to bounce and if this final factor hits then big selling will come to cause future drops going forward.

The first factor that is creating a risky market is the simple fact that the stock market valuations are now super high.

Take a look at this chart of cyclically adjusted P/E ratio for the S&P 500.

This ratio is a ten year average of the P/E ratio for the S&P 500 adjusted for inflation.  In September it reached the second highest level in its history, surpassing the levels reached in 2007 and in 1929, both of which were times of major stock market tops.

Of course this ratio has been elevated now for the past several years.

Stock market bulls have argued that near zero interest rates made stocks worth more so people could get dividends buying stocks.  But now that interest rates have been going higher that argument has no longer applied, which has been a reason for the recent selling in the stock market.

Another giant risk factor in the stock market is the fact that over the summer investors piled on a record level of margin debt.  The straight up run of last year only convinced the masses that risks in the market were practically eliminated and so some borrowed as much money as they could to buy more stocks.  Even the drop in February did not scare them.

This chart from the people at dshort.com makes this situation clear.

The combination of ultra-high stock market valuations and wild margin debt levels create a big risk for future selling in the stock market.

A dip in October hit the market, but certainly did not cause a collapse in the stock market.

What would cause a panic is if another drop takes the stock market down low enough to cause margin players to be forced to liquidate their holdings.

That could force selling to build upon more selling.

And that brings us to the third risk factor, which is the simple stock market cycle.

The market began a bull market in 2009 so people in the stock market have forgotten that bear markets can happen.

It's simply been so long since the last one, but this summer has seen the classic formation of a stage three topping process in the market.

That process will complete if the S&P 500 were to go through its Spring and October lows before the end of the year and lead to a stage four decline.

There are some things now that are ready to drop and should be considered doomed.

The simple solution is to raise some cash reserves in positions no longer doing well.

There are in fact five stocks that are widely owned inside the Nasdaq 100 that I would not buy now and would even consider selling if you own them.

I just made an important new report for you on these five stocks.  You can grab it for free and get my next market update by clicking here.