May 18, 2013
Busting The Bull Arguments
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“This market is nothing like 2000!”
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“You have to realize just how amazing the markets are right now.”
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“The ‘Walls of Worry’ have all been knocked down.”
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“The next stop for the markets is simply higher.”
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“This market is unstoppable.”
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“I haven’t seen a market like this in 30 years.”
Inside This Issue:
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Busting The Bull Arguments
Earnings Have Peaked
Earnings Yield Myth
Parabolic Spike Forming
Complacent, Ebullient &
Dangerous
Suggested Reading
These were all things that I either read, or heard, in just the past week. I even
read an article as to why that “This time is different – really!”
The Great American Divide
Bonds Aren’t Dead
S&P 500 At Extremes
Fed To Taper QE
5 Questions Bulls Must
Answer
ƒ Clues To The End Of QE
Here is an interesting statistic to think about for a moment.
Technically Speaking
The current rise in the stock market has gone uninterrupted for 181
days which is the longest period in the history of the stock market.
Think about that for a moment.
Over the last 113 years of stock market history we are now witnessing the
longest rise – ever. Every single time in history, when the markets have gone
on extended runs, they have NEVER, not once, lasted as long as the current
artificially fueled advance. What do you think is likely to happen next?
There is no doubt that the current advance is quite amazing. However, it is
not unstoppable. It will stop. It will correct. Of course, when it does, these
same “book talking jacklegs” that made the statements above will have a
litany of excuses has to why such a correction was unexpected. Of course,
those excuses won’t replace your lost capital.
DISCLAIMER: The opinions expressed herein are those of the writer and may not reflect those of Streettalk Advisors, LLC, Charles Schwab & Co., Inc.,
Fidelity Investments, FolioFN or any of its affiliates. The information herein has been obtained from sources believed to be reliable, but we cannot assure
its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Any
reference to past performance is not to be implied or construed as a guarantee of future results. See additional disclaimers at the end.
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ƒ Complacent, Ebullient &
Dangerous
Sector Analysis
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Oil And Energy Stocks
US Dollar
Interest Rates & Bonds
Gold
Emerging Markets vs. S&P
401k Plan Manager
ƒ No Change This Week
ƒ Click Here For Current
Model Allocation.
Disclaimer & Contact Info.
Busting The “Bullish” Arguments
Take a look at the first chart below. First, notice the recent run-up in the
market at the far right of the chart. This price action is very abnormal; it is
called a parabolic spike, but is similar to what was witnessed at the peak of
every previous bull market advance.
JOIN THE CONVERSATION
Secondly, one the primary “bullish” arguments has been valuations. The
argument is that stocks are “fairly valued” because valuations reverted to their
long term average during the financial crisis.
Take a look at the chart below. Never in history have valuations ONLY
returned their long term average before setting off into the next secular bull
market rise.
If you take a moment to inspect the chart above you will see that:
1. When P/E reversions begin they continue until valuations have fallen
well below the long term average. Bull markets begin with valuations
around 5-7x earnings with dividend yields between 5-6%. Currently,
the markets are trading at 23x cyclically adjusted earnings and 19x
reported trailing earnings. Does that sound cheap to you?
(Geek Note: You can NOT use forward operating earnings when
comparing to historical valuations which are based on trailing reported
earnings. This is the mistake every media outlet consistently makes.)
2. When markets are in the process of a long term valuation reversion
(blue dashed boxes) it is not uncommon for markets to have rallies
within the long term decline. Much as we have witnessed since the
beginning of the current reversion process.
3. It is not likely that this time is any “different” than what we have
witnessed in the past. While the interventions by the Federal Reserve
can certainly elevate markets short term – the underlying lack of
economic and fundamental strength will continue to put downward
pressure on the markets. Bottom line – valuations “ain’t” cheap.
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Earnings Have Peaked
Another key “bullish” argument has been the earnings and profitability of
corporations. Let’s take a close look at reported and operating earnings for
corporations since the beginning of 2000.
(Note: Earnings for Q1-2013 are only 92.7% complete as of this writing so
the chart is only through the end of 2012)
RECOMMENDED
READING
The Great “American” Divide
“Americans believe such a
family unit living in their
community needs more than
double that -- $58,000, on
average -- just to 'get by.'”
Why Bonds Aren’t Dead &
The Dollar Will Get Weaker
There have been quite a few
bold predictions, since the
beginning of the year, that the
dollar was set to soar and that
the great "bond bull market"
was dead.
The problem is that the analysts that try and forecast what earnings are going
to do in the future are always overly bullish. The chart below shows what
analysts were predicting earnings to be for 2012 through 2013 at the
beginning of 2012. What actually happened was markedly different.
S&P 500 Now At Extremes
Chart of the day. S&P now at
levels normally associated with
bull market peaks.
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As you can see above analysts are once again predicted a strong increase in
earnings per share over the next three quarters. This is a big part of the
“bullish” thesis for the “cheapness” of stocks versus other assets.
However, as the chart of our economic composite below shows, these
estimates are likely to come up fairly short.
RECOMMENDED
READING
Fed May Taper QE Before
September
Bloomberg interview discussing
my views on Fed’s potential
actions.
5 Questions Every Market
Bull Should Answer
If you believe that the market
has currently entered into the
next great bull market cycle you should be able to answer
these questions.
It is important to remember that there are TWO ways to increase earnings
PER SHARE. The first is to actually increase revenues at the top line. The
second is to reduce the number of shares outstanding through stock
buybacks.
According to a USA Today article out this weekend:
“Flush with cash and a world of opportunity at their doorstep,
companies have decided there's nothing more attractive than
themselves. So, they're offering big money to buy back their own stock.
This year, big U.S. companies have given the go-ahead for $286 billion
of buybacks, up 88% from the same period last year, according to
Birinyi Associates, a market research firm. If the pace continues for the
rest of the year, the tally will exceed the record set in 2007.”
Clues To Watch For The End
Of Q.E. “Infinity”
The current round of Q.E. by
the Fed does have a finite life.
Here are the clues to watch for
to signal that QE is coming to
an end.
First, the article is entirely wrong. Companies are not buying their own stock
because they view the world, the economy or themselves as particularly good
investments. Companies are buying their stock back to lower outstanding
shares in order to “beat” Wall Street estimates.
“Stock buybacks,” on average, are a miserable use of cash for corporations.
It is not a sign that they are “betting on themselves” because when stock is
repurchased it is retired reducing the number of shares outstanding.
However, it is evidence that management has nothing more profitable to do
with the money.
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Think about it this way. If you owned a business, and were excited about
future prospects, you would be using record stock prices as capital to acquire
other companies, your excess cash to expand production and services,
increase employment and build inventories. That, to say the least as
evidenced in the chart above, is not happening to any great degree.
Earnings Yield Myth
The final “bullish” thesis argument is that earnings yield makes stocks a better
investment than bonds. I have written about this particular myth several
times in the past and you can read the entire article “The Fallacy Of The Fed
Model” on the site.
“The bottom line here is that earnings yields, P/E ratios, and other
valuation measures are important things to consider when making any
investment but they are horrible timing indicators. As a long term,
fundamental value investor, these are the things I look for when trying
to determine "WHAT" to buy. However, understanding market cycles,
risk / reward measurements and investor psychology is crucial in
determining "WHEN" to make an investment. In other words, I can buy
fundamentally cheap stock all day long; however, if I am buying at the
top of a market cycle then I will still lose money.
It hasn't been just the last decade either with which the "Fed Model" has
continually misled investors. An analysis of the previous history of the
concept shows it to be a very flawed concept and one that should be
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sent out to pasture sooner rather than later. During the 50's and 60's the
model actually worked pretty well as economic growth was
strengthening. Interest rates steadily rose as a stronger economic
growth allowed for higher rates which enticed higher personal savings
rates. These higher savings rates were lent out by banks into projects
that continued further stimulated economic growth.
The bottom line here is that earnings yields, P/E ratios, and other
valuation measures are important things to consider when making any
investment but they are horrible timing indicators. As a long term,
fundamental value investor, these are the things I look for when trying to
determine "WHAT" to buy. However, understanding market cycles, risk /
reward measurements and investor psychology is crucial in
determining "WHEN" to make an investment. In other words, I can buy
fundamentally cheap stock all day long; however, if I am buying at the
top of a market cycle then I will still lose money.”
Another yield spread case that is made is that the spread between the 5-year
bond and the dividend yield on stocks is currently compelling evidence for
owning stocks. I beg to differ as shown in the chart below.
The last time the yield spread was this low (inverted chart) the market
remained range bound for the next 15 years as the yield spread increased
(both rates and dividend yield rose). However, it wasn’t until this spread
peaked in early 1980, and begins to reverse course, that the next secular bull
market period began.
With the current spread near historic lows the most logical path in the future
will be a reversion of the spread. This does not bode well for future stock
market performance.
If the prognosticators of a bond market reversion are “right,” like Bill Gross,
this becomes a much bigger issue.
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A Parabolic Spike In The Making
The rush into equities, particularly in the last month, has sent prices deviating
from their long term rising trend into what is known as a parabolic spike.
Parabolic spikes in assets prices NEVER, and I repeat NEVER, end well.
The last time I wrote about a parabolic spike in an asset was when we were
discussing the price of Gold during the 2011 debt ceiling debate. At that time
I specifically stated that:
“Should I buy gold now? In a one word answer…Are you kidding me – Gold
has never been this overbought before and if you ever want to be the poster
child of buying at the top – this is it. Okay, not really a one word answer but
here is my point. Gold is currently in what is known as a ‘Parabolic Spike’.
These do not end well typically as it represents a ‘panic’ buying spree.
Here was the chart I posted at that time. You know what happened next.
Does anything look similar in the following chart of the S&P 500?
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Yes, if you are an adept trader, and are willing to trade the parabolic lift, you
are welcome to do so. However, if you aren’t, you will likely wind up losing a
large chunk of your principal balance when prices revert. Such parabolic
spikes usually fall just as rapidly as they rose and generally revert the same
distance.
As I discussed this past week:
“Market prices are subject to gravity (the long term moving average) and
the longer the duration of the moving average the greater
the "gravitational pull" that exists. One way to measure extremes of
price movement is through the use of standard deviation. One
standard deviation from the mean (average) encompasses 68.2% of
potential outcomes within a given distribution of data which, in this case,
are market prices. Two standard deviations encompass 95.8% of all
potential outcomes while three standard deviations encompass 99.8%
of all potential outcomes.
The chart below shows a MONTHLY chart, which is a very slow moving
analysis, of the S&P 500 overlaid with Bollinger Bands which represent
2 and 3 standard deviations of a very long term (34 month) moving
average.“
“At the peaks of the "Internet Bubble" and the "Credit/Housing Bubble"
the market never got significantly above 2-standard deviations. Today,
we are encroaching well into 3-standard deviation territory. Standard
deviation analysis tells us that roughly 99% of the potential movement
in prices, from the bottom of the correction in 2011, has been
achieved. Furthermore, the extension of the market above the long
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term moving average is also at levels that have previously been
associated with major market tops.
The top graph is a very long term (150 month) measure of overbought
and oversold conditions. It is also warning that the current market
environment is stretched very far and that further gains are likely to be
limited without a correction first.
However, therein lays the potential problem. Looking back at the
markets during a bullish trend the market is usually contained between
the long term moving average and 2-standard deviations above the
mean. However, when the extension is above the long term mean
subsequent corrections are generally more associated with mean
reversions. A mean reversion is where prices fall an equal distance in
the opposite direction or well below the long term moving average.
The current level of overbought conditions combined with extreme
complacency in the market leave unwitting investors in danger of a
more severe correction than currently anticipated. A correction to the
long term moving average (currently around 1350) would entail an
18.5% correction. A correction to 2-standard deviations below the long
term moving average (which is most common within a mean reversion
process) would slap investors with 33% loss.
If you don't think a 33% loss is possible you should be aware that that
is about the average draw down of the markets during a normal
recessionary cycle. Not only is such an event possible - it is probable
when, not if, the economy slips into an eventual recession.”
STREETTALK
ADVISORS
What makes us different?
It’s really pretty simple. We
believe that managing risk is
the key to long term success.
Conserve the principal and the
rest will take care of itself.
Risk = Loss
Seems like a simple concept –
yet most people take way too
much risk in their portfolio which
is fine as long as the market
goes up. The problem comes
when it doesn’t.
Managed Risk = Returns
By applying varying levels of
risk management to a portfolio
of assets the potential for large
drawdowns of capital is
reduced thereby allowing the
portfolio to accumulate returns
over time.
Complacent, Ebullient & Dangerous
There is virtually no “bullish” argument that will withstand scrutiny. However, it
is the lack of scrutiny by investors that continually leads to their eventual
demise.
We remain long the stock market for now as long as the markets remain in
their bullish and positive trend. However, when that trend ceases to exists we
will be lower our target model exposure accordingly.
This is a dangerous market as the current extension is only seen at major
market peaks. However, these extensions can go further, and for longer, than
you can imagine.
Of course, these types of markets are like a game of “musical chairs” –
unfortunately, the major market players will already be seated before the
music stops leaving the average investor out of the game.
Total Return Investing
We believe that portfolio should
be designed for more than just
capital appreciation. There are
times when markets do not rise.
During those periods we want
income from dividends and
interest to be supporting the
portfolio.
If you are ready for something
different then you are ready for
common sense approach to
investing.
Get Started Today!
Have a great week
Lance Roberts
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Technically Speaking
Complacent, Ebullient & Dangerous
The following three (3) charts I present without commentary strictly as a
supplement to the article above. They are presented in order:
Complacency: Volatility Index
Ebullience: No. Of S&P 500 Stocks Above The 200 Day Moving Avg.
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Dangerous
There are more than enough warning signs to tell you that you need to be
paying very close attention to your portfolio at the current time.
When the current rise will end – no one knows for sure. However, I am sure
of one thing – something will happen, and it will be totally unexpected, that
will trip the market up at least on a short term basis.
The problem is that the markets are now ripe for a longer term reversion as
recent exuberance, boosted by continued Fed interventions, has elevated
asset prices against a backdrop of deteriorating fundamentals.
Yes, it is absolutely true that the fundamentals could turn the corner and place
catch up with valuations. The only problem is that historically that has never
been the case. Of course, I guess this time “could be different.”
See you next week.
Lance Roberts
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Sector Analysis
Oil And Energy Stocks
Oil is forming a very concerning pattern. This long and drawn out
consolidation process, which is refining itself into a very tight pennant pattern,
will either break out to the upside for a major move higher, or, to the downside
resulting in much lower oil prices.
Secondly, oil stocks are majorly diverged from the underlying oil price. Oil,
and energy related stocks, are set up for a massive downturn in the months
ahead. If oil breaks $87.50 reduce energy related positions sharply.
US Dollar
The dollar broke out of its recent consolidation pattern last week to the
upside. With the market as extended as it is currently, and with the dollar at
extreme overbought levels, my best guess is that the current move will not
last. Particularly with deflationary forces picking up steam globally.
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Interest Rates & Bonds
As with the dollar – deflationary pressures are picking up globally which
means that interest rates are likely headed lower rather than higher. The
“bond bull market” is still likely quite a long ways from being dead.
Bonds are not oversold enough just yet to warrant adding exposure here but I
suspect by the next newsletter we will have a decent entry point.
Gold
We discussed in recent missives the breakdown in gold and that exposure to
gold should be reduced on any rally to resistance.
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That rally has occurred and we sold one-half of our holdings accordingly.
Gold is now retesting its plunge lows, again as expected, and the critical test
will be whether it can turn those lows into support.
We do NOT recommend adding any precious metal exposure to portfolios at
this time. The trade in commodities in general, but particularly gold, is now
broken due to rising deflationary pressures.
S&P 500 vs. Emerging Markets
Emerging markets are dependent upon the U.S. for the strength of their
economy and markets. This is why emerging market stocks tend to lead
domestic stocks in advances as well as downturns.
The recent divergence between the S&P 500 and Emerging Markets is
particularly alarming.
See you next week.
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401K Plan Manager
As first quarter earnings
season begins to wind down
all eyes will turn back to the
economic data.
Unfortunately, that data has
not been good as of late.
The markets are getting
extremely overbought, as
discussed above, and the
risk of being “long” the
market is rapidly rising.
However, no technical trends
or supports have been
violated currently so we
remain fully allocated to the
market
until
something
changes. However, as we continue to recommend, if you are overweight in
your equity exposure it is recommended that you reduce to target weights
and rebalance the proceeds into cash and fixed income.
If you are underweight equities – do nothing and remain patient until the
market gives us a better opportunity to increase equity related risk.
If you need help after reading the alert; don’t hesitate to contact me.
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Disclaimer & Contact Information
Disclaimer
The opinions expressed herein are those of the writer and may not reflect those of
Streettalk Advisors, LLC., Charles Schwab & Co, Inc., Fidelity Investments, FolioFN, or any
of its affiliates. The information herein has been obtained from sources believed to be
reliable, but we do not guarantee its accuracy or completeness. Neither the information nor
any opinion expressed constitutes a solicitation for the purchase or sale of any security.
Past performance is not a guarantee of future results. Any models, sample portfolios,
historical performance records, or any analysis relating to investments in particular or as a
whole, is for illustrative and informational purposes only and should in no way be
construed, either explicitly or implicitly, that such information is for the purposes of
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or that Streettalk Advisors, LLC or any of its members or affiliates have achieved such
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STREETTALK ADVISORS
Lance Roberts
Director of Fundamental & Economic
Analysis
Michael Smith
Director of Alternative Investments
Luke Patterson
Chief Investment Officer
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Compliance Officer
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General Partner – Streettalk Insurance
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