Another US Equity Bubble is Blown

August 29, 2016

After hovering, or essentially going nowhere, for two straight weeks, the S&P500 dropped 0.7% last week on light volume. Volatility, meanwhile, crawled back up, which is perfectly normal in a week in which the price index declined. That said, the VIX index is still near the lows of the year, meaning that investors are far from being overly worried.

Last week’s economic news was mixed. The Chicago Fed National Activity Index inched up, improving slightly over the prior month’s reading. New home sales beat expectations. Durable goods orders also beat expectations, and initial jobless claims were slightly lower (or better) than predicted. On the down side, existing home sales missed consensus estimates. The Richmond Fed manufacturing survey also disappointed. PMI manufacturing flash fell, instead of rising as expected. The Kansas City manufacturing index contracted again. The FHFA house price index disappointed. And finally, consumer sentiment missed badly—instead of rising as expected, it fell from the prior month’s reading.

The slight decline in the S&P500 last week did little to change the technical picture. On both the daily and the weekly charts, the S&P is still extremely overbought. But on the daily charts, a slight topping formation is beginning to take shape. This suggests that at least in the short term, some sort of correction may be in the cards. But on the longer term weekly charts, prices still look like they’re simply stretched to the upside. And since prices have moved well above the 200 day moving average (which itself has turned upward in terms of slope), many technicians will switch to trading the index from a bull market perspective—they’ll buy the dips towards the 200 day moving average, and they’ll sell the rips, or big surges well above the 200 day moving average.

So not, over seven years after the S&P500 bottomed (March 2009), the US Federal Reserve has succeeded in blowing another major bubble in the US stock markets. This is the third major bubble in the last 16 years: the first one peaked in 2000 and the second one in 2007.

As always, this doesn’t mean that this market is about to crash. But it does mean that when it does finally correct….in a meaningful way….that the downside will probably be far more severe than it would have been if another bubble had not been engineered.

This also means that for anyone who’s invested in US stocks to actually benefit from this bubble, they will have to sell out of the markets well before any bear market arrives. And unfortunately, any simply study of investor behavior—in the run up to bubble peaks and in the subsequent declines—shows that almost all investors fail at this last, but crucial, step. Almost everyone who enjoys the ride up will ultimately suffer on the way down, because they invariably fail to exit at, or near, the peak.


August 22, 2016

Another week has gone by and once again, the S&P500 has gone pretty much nowhere. Last week, the large cap index closed virtually unchanged. Volume was extremely light, in large part due to the end-of-August vacation season. And volatility also barely budged; it continued to hold near the lows of 2016.

To mirror the lack of direction in the US equity markets, the economic news flow was also very slow. The Empire State Manufacturing Index missed badly, relative to expectations. Consumer prices met expectations; although consumer prices excluding food and energy rose slightly less than expected. Industrial production came in stronger than expected. Jobless claims were slightly better as well. The Philly Fed business outlook only met expectations and leading indicators beat consensus estimates.

In terms of technical analysis, the picture is as follows—upward price momentum is stalling (a reasonable conclusion after two straight weeks of going nowhere) but prices remained pinned up against or near all-time highs. As mentioned last week, from these lofty, overbought levels, it’s normal to see some sort of modest pullback. But in a world where central banks have pushed short term interest rates down to below zero around the world, what’s been normal over the last 100 years may not be so normal today.

But what remains true, despite the massively overbought and overvalued US equity markets is this simple fact—the more equity markets rise today, the lower the remaining returns will be in the future for anyone who remains in these markets. What this means is that the huge appreciation in equity markets over the last several years has reduced the prospective returns for everyone who invests in equities today.

Clearly, the converse is also true, but for the prospective returns to jump back up even to reasonably normal levels, the equity markets would have to retreat by a meaningful percentage. And by meaningful, we don’t mean just 10% or 20%, but something much more than 30%.

Back in 1929, a nationally known economist from Yale declared that US “stock prices have reached what looks like a permanently high plateau”.  He was proven to be spectacularly wrong, after stocks crashed over the ensuing three to four years.

Nobody knows exactly when, but today’s high plateau will also not endure. And when it breaks, the downside—-as informed by history—-could be depressingly huge.

Treasury Rates vs the S&P 500

August 15, 2016

On very light volume, the S&P500 ended last week virtually unchanged from the week before. Volume was light mainly because of the calendar—peak summer vacation season. And S&P volatility also barely changed; but that’s probably more a function of the fact that the VIX index was already at the lows of the year and had very little room to fall further.

With the lack of movement in the S&P last week, the technical picture remains unchanged—the S&P500 is extremely overbought. On both the daily and weekly charts, the S&P is pushing the upper limits of many commonly followed indicators. Any sort of pullback, from these lofty levels, would be very normal and almost expected.

As far as economic news goes, last week as a big disappointment. Productivity was a total disaster; instead of rising as expected, it fell. And the continued deterioration in labor productivity is important because it will directly impact future corporate earnings….negatively. Initial jobless claims, while still very low, came in a bit higher than expected. Import prices rose instead of falling as predicted; this too will hurt corporate profits. Retail sales were a disaster—both headline and core (excluding autos) sales missed badly. And consumer sentiment also missed. Only wholesale trade and business inventories beat expectations…..and even then, only slightly.

Finally, another major divergence has developed between US Treasury rates and the S&P500. While the S&P ended the week just about at all-time record highs, the US 10 year rate finished the week with a 1.5% yield. And since the 10 year yields (as opposed to 10 year prices) usually move together with the prices on the S&P, this sets up a massive problem—the super low yields on the 10 year suggest that the prices on the S&P500 ought to be much lower. Of course, some would argue that the US Treasury market is wrong and that those yields ought to rise in order to “converge” with the all-time high prices in US equities. But one has to remember that “mom and pop” investors (ie. unsophisticated investors) do not participate in bond market trading nearly to the extent that they do in stock market trading. in other words, the dumb money is far more commonly found in stocks, not bonds. And if that’s the case, then these super low Treasury yields are suggesting that the stock market investors…..sitting on all time high prices…..are super wrong.


Crude Oil Falling …. Again

August 8, 2016

Last week the S&P500 managed to eke out a small gain, rising 0.4% on light volume. Volatility dipped back down, this time down to set new lows for the year; that said, volatility always tends to set yearly lows during the summer months when traders tend to take time off from the markets and take vacations.

So while new, yet marginal, all-time highs have been set in the S&P, the technicals still point to an extremely overbought market. On both the daily and more importantly the weekly charts, the S&P is pressing up against the upper levels of several well-followed ranges, such as the Bollinger Bands. What makes the technical situation even more risky is the fact that on a fundamental basis, the S&P500 is also extremely overvalued. For example, many price to sales and price to earnings measures now show that the S&P500 is more overvalued than at any time (other than in 1929 and 2000) in the last 100 years!

Still none of this means that it can’t rise even further.

Except for one big report, most of the economic news last week was disappointing. ISM manufacturing disappointed. Construction spending reported the weakest annual growth since 2011. Personal income missed expectations; personal spending beat expectations. ISM services also missed consensus estimates. Initial jobless claims came in worse than expected. International trade missed, and consumer credit growth also missed. The big beat of the week was the payrolls number which came in stronger than expected. But as usual, what this report does not specify is the quality of the jobs created. While more and more well-paid and benefited factory jobs continue to disappear, low-paying and unbenefited service jobs are growing. But it takes more than one job as a bartender or waitress to replace one lost factory job. Yet the BLS does not distinguish between the two.

Finally, back in January of this year, crude oil (West Texas) set a multi-year low in the upper $20’s. The problem with such a low oil price is that it virtually destroys the profits and the balance sheets of thousands of important companies in the energy space. And since this sector is so large, relative to the US economy, it’s implosion alone could adversely impact the entire economy. Yet since January, the price of oil has rebounded and in May it touched $50. Unfortunately, since then, it has turned back down, and last week oil fell back under $39.

So it will be interesting to watch what happens to this super important commodity over the next several weeks and months. Because if it drops back down into the low $30’s or worse, into the $20’s, then we will almost certainly see widespread bankruptcies in the energy space, and this could “spill over” to the rest of the US economy.


Gold and Silver Still Rising

August 1, 2016

While this was no major reversal, the S&P500 did at least stop rising. Last week it gave back a tiny 0.07% on moderate volume. Volatility crept back down near the lows of 2016, lows that were set in mid-July. So even though investors have enjoyed a big post-Brexit bounce, it’s worth noting that the S&P500 is still sitting only about 2% above the highs it established in mid-July of 2015, over a year ago. And broader indices such as the NYSE composite are actually below where they were in July 2015. The point is that despite the big move over the last 30 days, the S&P has delivered a very meager return to investors over the last twelve months…..and it’s important to remember that this return has been generated with substantial risk—the S&P is an investment class than can lose (and in the past has lost) over 50% of its value, in a relatively short period of time. By comparison, investors who’ve owned 10 year Treasuries over this same period have not only enjoyed a higher rate of return, but they done so with substantial lower risk of loss.

From a technical analysis perspective, the S&P still sits at extremely overbought levels. And after last week’s slight retreat, the odds of a more material pullback have increased—specifically because the upside momentum indicators have stalled and have even started going into reverse.

In US economic news, there were a lot of disappointments last week. US home prices, as measured by the Case Shiller index, have started to slow their appreciation; while still rising, the rate of the price growth is dropping notably. PMI flash services missed expectations. Durable goods orders were a disaster; both the headline and ex-transportation results missed badly. Pending home sales also missed. Wholesale trade missed. International trade missed. Initial jobless claims were worse than expected. Consumer sentiment missed. The Kansas City Fed manufacturing index missed, and the latest GDP figure missed badly…coming in a less than half the expected growth rate.

As mentioned above, one asset class that’s done very well over the last year is US Treasuries. But another asset class, far smaller and less promoted in the mainstream media, has done even better. Both gold and silver have been booming lately. Since bottoming in December of 2015, gold has jumped over 25%. And silver has soared by about 50% over the same time frame. Why are these precious metals exploding? It’s not quite clear exactly what the reason is. But the last time these two metals made similar moves—off important lows—back in 2008, the both went on to climb much further. Gold peaked after climbing about 150% and silver peaked after skyrocketing about 400%.

So keep an eye on precious metals. Despite the already impressive moves over the last six months, they could both enjoy far more upside over the next 18 months.