3 Early Indicators of Stock Market Trouble You Need to Start Watching

By Shah Gilani
With more than $247 trillion in outstanding debt across the globe, borrowers and lenders look like they hold the keys to the future of equity markets.

But the reality is, bond investors and bond traders are the fulcrum between borrowers and lenders.

They are the ones who hold the future of equity markets in their increasingly slippery hands.

Here’s what’s weighing on bond traders and what plays you can watch if those slippery hands drop the weight of some the world’s debt mountain on equity markets…

The Looming Debt Mountain

When it comes to debt, the most important component of any equation is always what interest rates are doing.

If the cost of securing loans or rolling over loans or servicing existing debt is rising because interest rates are rising, equity markets are going to be affected.

Global equity markets have enjoyed a long climb out of the 2008 financial crisis, and most have risen beyond previous all-time high levels. That’s thanks to the exceedingly low interest rate environment engineered by central banks everywhere. Some interest rates were even pounded into negative territory, meaning rates were negative and lenders started paying borrowers for the privilege.

That’s changing.

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Over in the biggest bond market in the world, the U.S. Treasury bond market, the U.S. Federal Reserve’s already raised rates twice in 2018 and has almost promised two more hikes this year.

Still, the Treasury bond benchmark, the U.S. 10-year Treasury note, which scared equity investors and bond investors by ratcheting above 3% earlier this year, fell back into the 2.85% range for months, and only now looks like it’s heading back above 3%. It traded around 2.964% yesterday.

The iShares 20+ Year Treasury Bond ETF (NasdaqGM:TLT) is a great proxy for the Treasury market and the bond market in general. The price of TLT, which is now just above $119, rises when interest rates are heading lower, which causes bond prices to rise.

But, TLT’s been falling lately as rates are set to rise.

TLT has major support at $116. If it starts heading down, there’s your early warning sign that trouble is brewing for both bonds and stocks.

If TLT gets to $116, I recommend buying puts on the ETF with a strike as low as $110 if you buy longer-term options. If TLT breaks its support at $116, then breaks major support at $115, it’s going to get ugly.

The Global Canaries Are Singing

Another hot spot and market bellwether I watch is the iShares MSCI Emerging Markets ETF (NYSEArca:EEM).

Emerging markets, as heavily indebted as they are, especially those borrowers who took out dollar-denominated loans, are prone to a sell-off if rates rise and if the dollar rises, and will get hit extra hard if the dollar and rates rise at the same time, which in any bond market selloff they will do in tandem.

If EEM gets down to $40, it’s a sign of trouble. It had a good run higher from 2016 through 2017, but has been falling backward since the start of 2018.

Right now, EEM’s around $44.53 and could make a move back up to $45. If it does get back above $45 and can’t hold that level and breaks back to $44, consider it an early warning sign of more EEM trouble.

I’d be a buyer of puts under that scenario. However, EEM may not have a chance to get back above $45. In that case, I’d be looking to short it or buy puts on the ETF if it trades below $42 while TLT at the same time is trading below $118.

Then there’s China, a monumental debtor nation. If the Chinese stock market crashes, and it’s already down more than 20% this year (that’s a bear market), we’ll see global contagion on a huge scale.

I use the iShares China Large-Cap ETF (NYSEArca:FXI) as my China market proxy. FXI is down from $54 to around $43.76. If FXI breaks its neckline support at $40, it could drop quickly to $30. So, I’d want to buy puts as soon as it breaks that level.

Those are three “global” indicators I watch and trade and the levels where I’d be taking action.

As far as U.S. equity markets go, if these global canaries start singing off key, it will mean some of the debt mountain is crumbling and markets are going to get buried.

In that case, I’d be shorting U.S. equity markets with a vengeance.

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