Why the Stock Market Could Be Set Up for a Sudden Plummet

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Investors need to be careful, as the risks on key stock indices are continuously piling up. They need to keep a close eye on their portfolio, and maybe should consider taking some profits off the table.

Since the beginning of the year, key stock indices, like the S&P 500, have been constantly increasing in value and making new highs. Recently, we witnessed the S&P 500 reach above 1,700, and other key stock indices, like the Dow Jones Industrial Average, entering uncharted territory as well.

With these increases, investors are now asking: how high can the key stock indices really go?

Looking at the broader picture, the U.S. economy isn’t performing as well as the key stock indices are suggesting. In times of high economic activity, the stock market tends to perform well. This is not the case for the U.S. economy as it stands, as the U.S. gross domestic product (GDP) only increased at an annual pace of 1.7% in the second quarter of this year. (Source: “Gross Domestic Product, second quarter 2013 (advance estimate),” Bureau of Economic Analysis, July 31, 2013.)

On top of this, the unemployment situation is still bleak in the U.S. economy, risking deterioration in consumer spending. The average American Joe is still facing many problems: look at food stamp usage and the amount of homes under negative equity, for instance.

Adding to the worries, the global economy is also showing signs of deep stress, with countries across the map showing concerns. For example, China is expected to show a significantly lower growth rate compared to its historical average this year, and the eurozone remains troubled with debt-infested nations still in recession and the stronger ones facing anemic growth.

From a more focused viewpoint, the earnings of companies on key stock indices are improving, but they are not as impressive. Consider this: as of July 26, 73% of the companies on the S&P 500 that reported their corporate earnings beat expectations. Unfortunately, as great as this may sound, little more than half of them registered revenues above expectations. (Source: “At mid-point, S&P 500 companies beating estimates by 2nd smallest margin since 2009,” FactSet, July 26, 2013.)

This is important, because it suggests the companies on key stock indices may not be selling as much as is anticipated. Furthermore, we have also seen increased buybacks from companies on key stock indices, which essentially helps in engineering corporate earnings per share.

Where are key stock indices going next?

At the very core, the risks mentioned above are notable and shouldn’t go unnoticed.

Despite this, investors also should note that key stock indices may just continue to go higher for the short term, just simply based on momentum and optimism. There is a significant amount of bullish presence. Eventually, they’ll adjust and come back to reality. It can take time, but practicing good portfolio management techniques can protect investors from huge losses when that time comes.

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