On dismally low volume, the S&P500 jumped almost 2.3% last week. The dismally low volume means only one thing—investors were not rushing back into the US stock market to drive, and benefit from, this notable upward move in price. Instead, almost all of this move can be explained by short covering and by corporations using increased borrowing and operating cash flow to buy back their own stock, which is not exactly a good sign for future corporate growth and financial soundness. At the same time as the index moved higher, the VIX index dipped down to set 2016 lows. Investor complacency has fully returned to the US stock markets, as it often does during the summer months.
On Main Street, the uninspiring economic “recovery” continues to disappoint. The week started with a miss from the PMI manufacturing flash index. The Richmond Fed manufacturing index also missed badly. PMI flash services also disappointed. Headline durable goods orders beat estimates, but that was only due to volatile car sales (themselves lately fueled by unsustainable subprime loans promoted by the US government) which jumped; durable goods orders excluding autos, only met expectations. The latest estimate of US GDP growth missed consensus estimates and consumer sentiment also disappointed. On the positive side, new home sales beat estimates. And the pending home sales index also beat expectations.
The technical picture has suddenly become more cloudy. By jumping back so strongly last week, the recent negative momentum trends have been arrested. But because the S&P has not yet returned to the former highs set last year…..and because the volume during price rises is so weak…..the burden is still on the bulls to prove that the massive 18 month rolling top formation is no longer in effect.
And remember, that as the S&P500 has approached the former highs, aggregate corporate profits have been falling for over a year now. As a result, the index’s price to earnings ratio is soaring……making the index far more expensive (relative to profits) than it was in 2015 when it set all time highs.
All this brings us to a theme that professional investor John Hussman has been pounding the table about for many years—-that as US stock market indices become extremely overvalued, they become less attractive investments for savers. Simply put, he points out that extreme overvaluation NEVER remains in place perpetually. Valuations always correct back down to long-term levels (and usually over correct) eventually. So anyone who’s owned stocks over the last five years has benefited on paper tremendously, anyone who remains in the stock market (or even worse, anyone who decides to enter the stock market now) will not enjoy the same rates of returns (say over the next 10 years) that stock market investors have enjoyed over the prior five years. Why? Because the Fed’s monetary policies have front-loaded future returns, and the remaining, prospective returns are paltry. How paltry? Using 100 years of data, Hussman estimates that annual US equity returns over the next 12 years will range from 0-2%…..and that’s including dividends!
But wait, there’s more. During these next 12 years, Hussman confidently expects intermediate draw-downs of 40-55% in the S&P500. So to realize the estimated prospective annual returns of 0-2%, investors would have to ride out the massive, temporary set backs.
So what can someone who wants to beat the paltry 0-2% total returns do? Simple: wait, patiently, for the intermediate draw downs of 40-55% before buying US equities. But when these meltdowns occur, then one must be bold and buy……when most everyone else will be selling. By going against the crowd, prospective annual returns will be raised to approximately 10-15%.
Now that’s worth waiting for.