Over-Stretched

Despite series of daily ups and downs, the S&P500 managed to scratch out a gain of 0.79%. But this gain was built on the lowest weekly volume of the year, which in part was due to the holiday shortened week. Volatility fell back down into the mud. With VIX below 13, the S&P volatility index returned to multi-year lows.

Meanwhile, US macro data continued to struggle, with most of the results coming in below expectations. Durable goods orders (excluding the volatile transportation sector) fell, instead of rising as expected. New home sales missed, as did pending home sales. Consumer confidence plunged. While the Dallas Fed manufacturing survey beat expectations, the Richmond Fed and the Kansas City Fed both missed….badly. Fourth quarter GDP growth missed expectations and came in just above zero growth, which indicates that the economy is stalling. Jobless claims surged back up to almost 360,000. And personal income and spending came in just about as expected, again showing that the average family, by eroding their savings rate, is struggling to buy essentials.

Technically, the S&P is, in a word, over-stretched. Today’s prices are about as far above the 200 day moving average as they get, historically speaking. As already mentioned, volumes are anemic. This suggests that the recent market advances are built on a flimsy foundation, which could easily crumble. Breadth indicators are also over-stretched and weakening. The percent of stocks above their 50 and 150 day moving averages is near former peak levels and starting to turn down.

So what does this mean? Simple. The US stock market has divorced itself from the fundamentals of the  US economy. Prices are now implying that the current level of earnings—which are 70% above their long-term average ratio to sales—will continue indefinitely. This is the only way to argue that the P/E ratio is ‘cheap’. Not only will this extremely distorted ratio of profits to sales most likely not continue to be elevated, but history argues that this ratio will revert to and even below the long-term average.

Why? Because it always has in the past.

Suddenly, the E (or earnings) will come down….way down. And this means that if prices stay where they are, that the P/E ratio will soar and stay at those new lofty levels.

Once again, history shows that this will most likely NOT happen. What history suggests is that when Earnings revert back down, the price of stocks will follow them…….back down.

In short, the US stock markets are over-stretched. Buyer beware.

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