Paulsen Says `Proceed With Caution' Across Asset Classes

(Bloomberg) -- With U.S. stocks following their first quarterly loss in more than two years with an ugly April start, it's no wonder they're stealing the spotlight. But it's not just equities: Signs of stress have surfaced this year in other asset classes, too.

That's according to Jim Paulsen, the 60-year-old chief investment strategist at Leuthold Weeden Capital Management, who was named the most accurate forecaster in 2001 by Bloomberg Businessweek. He created an indicator that tracks tensions across asset classes called the “Markets Message Indicator,” and it's now rolling over after peaking in January at one of its highest levels in the past 40 years, a sign cracks may be starting to show across financial markets.

“Perhaps the Markets Message Indicator peak in January will prove only temporary. However, its current warning comes when the indicator is near the peaks of 2000 and 2007,” Paulsen wrote in a note to clients Monday. “That is, it suggests investor confidence and aggressiveness ‘across all financial markets' is nearly as pronounced today as it was at the last two major stock market tops.”

The gauge takes five different data points into account: how the stock market is performing relative to the bond market, cyclical stocks relative to defensive stocks, corporate bond spreads, the copper-to-gold price ratio, and a U.S. dollar index. The goal is to devise a gauge that acts as a proxy for broad market stress.

It's no secret this year's stock market has differed from last year's, one characterized by unprecedented calm and double-digit returns. But on top of that, stocks relative to bonds, and cyclicals relative to defensive stocks both recently declined even lower than during the depths of the February correction -- a sign of waning investor aggressiveness, according to Paulsen.

Even within fixed income there are some signs of worry. The spread on BBB corporate bonds, for instance, has widened 27 basis points since the end of January. “Anxieties among bond investors are worsening,” Paulsen said.

And as U.S. stocks stumbled Monday, junk bond investors began to waver. A measure of credit risk for U.S. high-yield bonds reached the highest levels since December 2016.

Commodities tell a similar story: that investors are positioning themselves more defensively. A common safe haven, gold, has begun to outperform copper, a more cyclical metal, suggesting a flight to safety driven by fear in the markets.

“Historically, this indicator has not been infallible, but its periodic cautionary advice has been extraordinary since at least 2000,” Paulsen wrote. “At a minimum, equity investors should not limit their attention simply to the struggles and messages coming from the stock market. Rather, chatter from all financial markets should be considered and currently they are jointly whispering to ‘proceed with caution!'”

--With assistance from Molly Smith

To contact the reporter on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Andrew Dunn, Randall Jensen

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