US Equity Valuation

May 27, 2014

Last week, the S&P500 inched up 1.2%, but it still remained in the range (albeit at the upper end of that range) established almost three months ago. Volume was very light; in fact it was the lightest week, excluding vacation weeks, of the year. Again, this means there is very little conviction behind the buying of stocks. And volatility fell to near one-year lows. So there is simply no fear that stocks can correct in any meaningful way.

Technically, the US stock market is now even more overbought than it was last week, and the week before that.  The S&P is now hugging or even crossing above the upper Bollinger bands on both the weekly and daily charts. While momentum is weaker than it was at the beginning of the year, and small cap stocks are significantly off their recent highs, the S&P remains in an uptrend, with prices well above the 200 day moving average and with that average sloping upward.

In macro news, the releases were light and mixed. Initial jobless claims jumped higher than expected. The Chicago Fed National Activity Index plunged back into negative territory, down from a somewhat positive reading the prior month. Existing home sales disappointed, especially as home mortgage rates have climbed over the last 12 months. Also in housing, mortgage applications dropped. On the positive side, New home sales were slightly better than expected, as was the Kansas City Fed manufacturing survey.

So now, almost halfway through 2014, how does the valuation of the S&P500 look from a historical perspective?

We all know that prices are hovering near all-time highs, but are these prices fair—when compared with historical markers—especially as so many pundits on financial news outlets keep asserting that US stock prices are not overly high…..and therefore not at risk of any serious correction.

John Hussman, of the Hussman Funds, does a great job highlighting some of these measures. And they’re not pretty. Recently, he states:

Valuation measures remain extreme, with the market capitalization of nonfinancial stocks pushing 130% of GDP (relative to a pre-bubble norm of about 55%)

Keep in mind, this is a favorite measure of none other than Warren Buffett.  Hussman also uses this:

the S&P 500 price/revenue ratio at 1.7, versus a pre-bubble norm of 0.8

And if one were to apply these measures to actual investment decisions, the implication would be that one should consider lightening up on equities and certainly NOT putting new money to work at these prices.

Note that for valuations simply to return to historical norms, using the measures above, prices would have to fall by MORE than 50%.

What Hussman didn’t mention is that prices tend to fall much more quickly than they tend to rise. This means that many years of advances in the S&P could be wiped out in a matter of months, when the S&P finally corrects. Recently, these types of fast losses happened after the tech bubble imploded in 2000 and the housing bubble blew up in 2007.

So if you do decide to stay all-in and put new money to work into stocks, you must either disregard all of the above, OR you must conclude that history will never repeat itself.

As Hussman so eloquently puts it—good luck with that.

US Treasuries Befuddle All the Experts

May 19, 2014

The S&P500 closed the week down a small fraction of one percent. Volume was very light and volatility approached the lows of the year. The S&P seems to be having a hard time breaking out and beyond the upper 1800’s, a level first reached in January and then again throughout the spring.

Momentum seems to be fading. MACD continues to diverge bearishly from the price level in the S&P (ie. prices are back to the old highs, but MACD is far lower). And while prices last week dipped  below the 50 day moving average, they did close above; this suggests that as a trader, one should still stay somewhat bullish and certainly not be heavily short. Prices are still well above the 200 day moving average and this average is still sloping upward. So upward momentum is weakening ,but the overall trend in prices is still up.

On the economic front, the news was fairly poor. Retail sales missed badly….both the headline number as well as the figure excluding auto sales. It appears that American consumers are running out of gas. The housing market index missed badly. Yes the housing market has rebounded somewhat over the last two years,  but this rebound is now showing signs of slowing down. Both consumer and producer prices were higher than expected when looking at the core figures; headline inflation, however, still remains firmly under control. Industrial production missed badly, as did consumer sentiment, which registered its biggest miss in eight years! On the positive side, the Empire State manufacturing survey and the initial jobless claims were better than expected.

Back in September 2013, we noted—in an entry titled US Treasuries on Sale?—that the 10 year Treasury had risen in yield (fallen in price) from 1.4% to about 3.0% and we suggested that this asset class might present a good opportunity in terms of value, and especially when many other asset classes seemed to be overpriced (ie. not offering a good value).

So how did we do?

Well last week, the 10 year touched 2.47% or well down form 3.0%. In the Treasury market, this represents a huge rise is price over a relatively short period of time.

In short, we were right.

But more importantly, we were right when virtually all of the Wall Street pundits were wrong. Almost all economists on Wall Street (yes, almost 100%) were forecasting that rates would rise over this period. In fact, the experts were so wrong, the Wall Street Journal recently published a big piece titled: “Stubborn Treasury-Bond Yields Touch a Low”.

In it, the author notes:

US government bond yields, which move inversely to prices, briefly touched their lowest level in six months Monday as geopolitical fears combined with uncertainty over global economic growth to push fund managers toward havens. The surprise strength in Treasurys is confounding bond-market bears: in 2014, US government bonds have gained more than the Dow Jones Industrial Average.

So what’s an important takeaway? The fact that all the experts can (and often are) wrong about such an important topic—in this case interest rates.

So when Wall Street insists that no recessions are on the horizon and stock prices will not meaningfully correct, please take note—these so-called experts are often wrong, and when they’re wrong, they’re wrong in a big way.

Equities—Still In Uptrend

May 12, 2014

The S&P500 dipped a fraction of one percent last week (0.14% to be exact) on light volume. Volatility was unchanged at the end of the week, from the prior week’s end. US equities appeared to be treading water during most of last week’s trading.

The US macro is still not getting any better. In a light week of announcements, PMI services disappointed. But ISM services beat estimates. International trade results met expectations. Productivity fell, which was a huge disappointment. Initial jobless claims slight beat consensus estimates as did wholesale trade. All in all, there was no sign that our economy is on the verge of anything resembling robust growth…..fully five years after the Summer of Recovery began in 2009.

Technically, stocks are still overbought, as they continue to hover near the upper Bollinger band on both the daily and weekly charts. Bullish sentiment is still super high, while bearish sentiment is ultra-low. This means US stock market investors and traders are overly bullish. Meanwhile, several indirect indicators are flashing warning signs. MACD is weakening on the daily charts, and so is RSI. The percent of stocks trading above their 50 day moving averages is much lower than it was near prior price peaks……while prices are now still very close to those peaks. All this suggests that the US stock market “internals” are weakening while prices are still near peak levels.

All that said, the US stock market….especially the S&P500….is still in an uptrend. And this uptrend must be respected until such time that (and for whatever reason) it breaks down.

The bottom line is that prices on the S&P are trading above the 50 day moving average and more importantly above the 200 day moving  average. And just as importantly, the 200 day moving average is sloping upward.

So until this 200 day moving average turns down, it is much too early to call an end to this bull market run. Yes, this run is getting very long in the tooth, and yes a serious correction is very much overdue, but until prices drop below the 200 day moving average and decisively enough to stay there long enough so that the 200 day moving average turns down, it would premature to call an end to the bull run.

Does that mean that you should boldly stay long with most of your money invested in the S&P? Of course not. Just because an avalanche doesn’t occur on the day, week, or month that you think it will (based on 100 years of historical data and analysis) doesn’t mean that conditions are not dangerous!

It only means that one should not rush to sell absolutely everything and start to massively short this market.

Not just yet.

US Treasuries Continue to Rally

May 5, 2014

The S&P500 rose 0.95% on very light volume last week. Volatility inched down, but only a bit because it has now almost returned back down to the lows of 2013.

Interestingly, the S&P climbed in the face of challenging news flow, especially out of Ukraine and the crisis that is now pitting the US and western Europe against Russia and possibly China. More than one government leader has warned that there are many similarities between this situation and the one that led up to World War I. So today, when analysts are sounding the alarms about WWIII, however remote the chances, the S&P500 simply shrugs them off and rallies on. Amazing.

Technically, the S&P500 remains very over-bought, pure and simple. On both the daily and weekly charts, the price is hugging the upper Bollinger band. But since the 50 day is above the 200 day moving average, and both moving averages are upward sloping, most every technical trader and investor will feel like there is no choice but to be long and stay long stocks. At the same time, however, lots of breadth indicators are weak or are weakening. Both the McClellan oscillator and the summation index have not returned to their recent highs the way S&P500 prices have. The same applies to new highs minus new lows, as well as the percent of stocks above their 150 day moving average—both of which are significantly weaker than they were at the prior stock market highs.

US macro results continue to be mixed. The Dallas Fed survey and the Chicago PMI both beat expectations, but consumer confidence, construction spending and the PMI manufacturing index all missed. The most important miss of the day was the horrible GDP result for the first quarter of 2014. Instead of growing at 1.1% as expected, GDP crept up at only 0.1%—-a massive miss. Initial jobless claims also missed badly. On the positive side, at first glance, payrolls rose more than expected. But beneath the surface of the jobs report, things were much uglier. Average hourly earnings didn’t rise at all—they were supposed to move up a healthy 0.2%. The labor force participation rate plunged to 62.8%, to the lowest level since 1978. About 800,000 jobless people left the workforce, because they were so discourage, and that means they no longer count as being unemployed. And that means the headline unemployment rate fell to 6.3% giving the appearance of a healthy jobs environment, when in fact nothing could be further from the truth.

Finally, starting about six months ago, we have been promoting the idea that US Treasury prices have fallen so much that they actually offered a good value. In other words, we projected that interest rates would fall over the following months.

At the same time, the consensus has been that US government interest rates would rise. And this view was strongly held and promoted by bankers, economists, and thousands of money managers around the world.

So what’s the verdict?

Well, about six months ago, the US 10 year Treasury hit 3.0%. Last Friday, it closed at 2.58% proving that the massive consensus among all those “professionals” was horribly wrong.

Not only did US Treasury rates not rise, they didn’t even remain unchanged. Instead, they plunged……just as we expected.

And the best part is that they may have even more room to fall.