The S&P500 jumped about 1.4% last week, on very low volume. Volatility, as measured by the VIX Index, dropped back down near the lows of the year.
So the technical picture is now more stretched than ever—on both the daily and weekly charts, the S&P is now hugging the upper Bollinger bands and is well above the 50 day moving average.
At the same time, valuations are more stretched than ever. While aggregate corporate profits remain stagnant, the multiples paid for these earnings are approaching record highs. The Shiller CAPE index for example is now approaching highs last seen in the run up to the dot-com bubble in the year 2000.
So what led to this sudden jump up in US equity prices? Unbelievably, it was a series of extremely bad US economic reports. Retail sales plunged; both headline and ex-transportation results were massive misses relative to expectations. Consumer sentiment missed. Core consumer prices and core producer prices also missed to the downside. Initial jobless claims were worse than predicted and the JOLTS survey also missed.
As a result of all this bad news, market traders and investors reasoned that the Fed would be forced to slow down its hiking program. And any slowdown in interest rate hikes is viewed as an accommodation to the equity markets. So bad news equals good news!
Meanwhile, Blackrock…..the major investment management firm….recently published a study showing that almost all the net purchases in the S&P500 since the 2009 bottom have come from only one source—US corporations buying back their own stock. At the same time, individual and institutional investors have been net sellers over this same time frame!
The catch is that most of these corporate buybacks have been funded not from operating cash flows (much of which have been consumed by normal capital expenditures) but by borrowing, borrowing that’s been facilitated by the Fed’s massive drive to lower interest rates. But now that the Fed is reversing its easing programs, these corporations are still left with their huge levels of debt, debt that will now need to be refinanced at higher rates.
So the ingredients are in place not only for a big stock market pullback in the US, but also for a huge corporate debt crisis. Corporations will find that they’re over-leveraged and that they’re interest rates are surging. This suggests that all risk assets—US debt and equities will suffer in the next financial and economic downturn.