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  • Michael Gayed has a bearish view on the stock market and says it’s up for a correction.
  • He uses intermarket indicators to pinpoint which way the stock market might be heading.
  • He suggested investors diversify by adding Treasuries, gold, and even cash to cushion a correction.

The stock market had its longest bull run in history prior to the Covid-19 crisis. Over the past 12 months of recovery, the S&P 500 has leapt 32%, and frequently makes new highs.

But Michael A. Gayed, an award-winning investment manager at Toroso Asset Management, says it’s the wrong kind of growth.

Gayed is the publisher of The Lead-Lag Report, a premium research service focused on the idea that if you want to kill it in the stock market, you have to proactively avoid getting killed. He works through the lens of intermarket analysis, which is the idea that the relative movements of different parts of the marketplace tell you something about the changes that may occur. He applies these concepts through three mutual funds that he manages.

The three main indicators he’s most known for are the predictive powers of the utilities sector, Treasuries, and the demand for lumber relative to gold. He recently told Insider what they’re showing him about stocks, particularly the latter two.

He views the utilities sector as one of the most unique in the stock market because it’s the most interest-rate sensitive and its earnings are driven by interest rate variability. That typically means when rates are falling along with the demand for money, utilities benefit because its companies are highly leveraged and can borrow more cheaply.

In the co-authored paper that won him the 2014 Charles H Dow Award, he further explained that utilities tend to beat the market in low-rate environments as investors are drawn to their cheaper cost of capital in a weaker economy. Currently, the utilities sector trails the S&P 500 year-to-date by about seven percentage points.

"If utilities outperform the stock market, that would suggest that the demand for money is likely falling," Gayed told Insider.

The same idea applies to Treasuries, he adds. As for the demand for lumber relative to gold, the correlation has predictive power because lumber is linked to the housing market, which is an indicator for growth, inflation, and credit creation. Meanwhile gold is a safe-haven commodity, meaning that during high-risk periods in the stock market, it tends to do fairly well, he said.

Therefore, most major crashes, corrections, and bear markets are historically preceded by strength in utilities and long-duration Treasuries, and weakness in lumber relative to gold.

Currently, the clearest indicators are the behavior of long-duration Treasury yields, which have been dropping since March, and lumber, which has gotten absolutely smoked coming out of the high from early May, Gayed notes.

He adds that if they continue dropping at their current pace, there would be two explanations, and both are tied to predictable and potentially damaging events - so-called grey swans. The first is the Delta variant that's making its rounds, and the second, the debt ceiling expiration and risk of a credit downgrade.

Another risk on his radar is that inflation is in fact transitory even after the amount of stimulus that has been poured into the economy to revive it.

"If inflation is transitory, the reflation narrative which has pushed headline averages higher proves to be false," Gayed told Insider.

Market trends

Moving away from macroeconomic indicators and just looking at stocks, Gayed adds that major mega-cap tech names are what's pushing the market relative to small caps and emerging markets.

He also notes that domestically oriented areas should be leading but have been lagging since February. Small-cap revenues are more domestically sensitive as they are more exposed to consumers' discretion, and their lag is probably because there's a feeling the pandemic may not be over.

For these reasons, he recommends that investors build up their hedges against a stock-market dip.

"The truest diversifiers historically are the ones that people hate the most: Treasuries, gold, and the dollar itself. Nobody ever wants to allocate to those because they don't really do very much until you have those periods of stress and high risk," Gayed said.

He continues, "If I'm right and the conditions do favor an accident, I'm using this analogy that I think it's the eye of the storm. If that's the case, then investors should probably think about simply reducing their overall beta risk exposure and diversifying into those areas."

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