A top 2% fund manager over the past 15 years shares 3 red flags that signal trouble ahead for major stock market indexes – and says these 2 investments are trading at deep discounts

The first is that short interest in the S&P 500 and Nasdaq 100 — stocks that investors have borrowed in the hope that they will fall — is extremely low. This signals that investor bullying may be very high. Investor sentiment has historically acted as an inverse indicator of future performance. Bank of America’s Bull/Bear indicator, for example, issues a buy signal when sentiment is weak and a sell signal when sentiment is bullish.

Second, the distribution of household capital is hovering around record levels, with 42% of household assets held in stocks. This is another indication that the feeling is very good. Allocations to stocks were only so high during the early part of the pandemic recovery and near the height of the dot-com bubble leading up to 2000.

Current equity allocation levels also indicate that the S&P 500 could be set to deliver negative returns over the next 10 years.

“High ownership levels have been a precursor to the index’s underperformance,” Smead said in the note.

Relatedly, recent Bank of America data showed that cash allocations among fund managers are at some of their lowest levels on record, another signal that investors are confident they can find better returns. good elsewhere. This is all the more surprising given the strong, risk-free returns that cash offers

“We’re contrarians and strangely long for the moments when history, psychology and mathematics are challenged in the US stock market,” Smead said. “We believe this is one of those points in time.”

While much of Wall Street remains bullish in the near term, Smead is not alone in his cynicism about the market’s ability to continue delivering strong returns over the long term.

Research Affiliates founder Rob Arnott says there are many sub-sectors and markets around the world that offer better return prospects than indexes like the S&P 500 – including international value stocks, REITs, small caps and developed market stocks not from the US.

“I’ve been called a permabear. I’m not. I’m a bull for things that are cheap,” Arnott told Business Insider in May. “I’m not a bear when it comes to things that are priced to give you double-digit returns, and there are a lot of those right now.”

Jeremy Grantham, the co-founder of GMO, has warned of the spectacular decline ahead of the S&P 500 given how high valuations have risen and said he likes quality and deep value factors.

For Smead, the best gains lie in oil and home stocks, which are trading at “50% discounts,” he said.

On oil stocks, he believes oil prices will stay above $80 a barrel and that analysts are underestimating earnings. Meanwhile, home stocks are suffering from weak investor optimism as interest rates remain high.

Investors can gain exposure to these sectors through funds such as the Invesco DB Oil Fund (DBO) and the iShares US Home Construction ETF (ITB).