By Cormac Mullen
(Bloomberg) --Risks are stacking up for markets attempting to recover from the latest provocation by North Korea and the mounting damage of Tropical Storm Harvey.
Citigroup Inc. strategists including Jeremy Hale cite “worrying developments” that may signal the approach of a correction in stocks, while Commerzbank AG finds growing evidence of bearish sentiment in bond funds. Here are some of the red flags:
The pairwise correlations between the S&P 500 and its industry sectors have fallen near levels that preceded the last two bear markets, according to the Citigroup strategists. The previous downturns in stocks started when correlations re-established themselves.
Underperforming transport stocks are another concern. The Dow Jones Transportation Average, a gauge of airline, railroad and trucking companies, has fallen about 5 percent from its July 14 high. The index’s decline from its 2014 peak led a similar move in the S&P 500 by about seven months.
The ratio of outstanding puts to calls on the S&P 500 has risen to levels last seen in the late-2015 market sell-off, according to Richard Turnill, BlackRock Inc.’s chief investment strategist. The ratio for German stocks has also risen. The move to boost downside protection shows investors are getting nervous, he said.
Fund flows show bond investors are also shunning risk. While high-yield funds suffer ‘considerable’ redemptions, cash has flowed into those that invest in government debt, according to Commerzbank strategists including Alexander Kramer and Ulrich Urbahn.
Equity investors are willing to pay more for protection against losses than gains. So-called equity implied volatility skews are above the 10-year average, according to the Commerzbank strategists. This implies they are willing to pay more for downside protection than upside potential compared to the last decade.