'Too Far, Too Fast': A Look at Asset Classes

As we listened to Bloomberg all day, we lost count of the number of times anchors or guests said the market has gone “too far, too fast” — it sounded like group think and crowd behavior. While we do tend to agree with the assessment and have said so before today, it lost all effect after hearing it a thousand times. Everything that happened today probably cannot be effectively explained by that single crowd mantra, except for a domino effect that one market may have on the other.

Let’s look at the data to see how “how far, how fast” different asset types have moved in this rally.

To do that we generated the following charts that show the percentage price change, the RSI and the ROC for a variety of stock and bond funds.

RSI (Relative Strength Index) is an oscillator (as opposed to trend follower) plotted on a scale from 0 to 100. Values above 70 are considered overbought and values below 30, oversold.

ROC (Rate of Change) is an oscillator that measures the percent change in price over a selected period of time. It oscillates above and below the zero line as the rate-of-change moves from positive to negative. Overbought and oversold conditions need to be ascertained on a security-by-security based through examination of its history.

There are certainly other tests for “too far, too fast”, but these two criteria do not paint a clear picture to support the singular “too far, too fast” explanation.

Divergence between the direction of prices and earnings estimates might be an important factor as well. Estimates have been coming down, while prices have been going up. Bloomberg pointed out that the forward operating earnings P/E for the SPY at the March low was about 11, and as of last Friday stood at about 16. The multiple had expanded much farther than the prices increased due to the divergence between prices and earnings estimates. “Too expensive” is related to, but not the same as, “too far, too fast”.

Here are the RSI and ROC plots for several important and/or recently popular funds:

click image to enlarge

You can draw your own conclusions from the pictures.

[Securities shown in the charts: SPY, EFA, EEM, FXI, VNQ, DBC, GLD, USO, UNG, AGG, TLT, MUB, LQD, JNK]

Disclosure: we own most of these securities at one time or another in various managed accounts.

Comments

[sdavid0419:]

This market game is perfect for politicians. You can spin anything anyway you want. Take the GLD chart:

If you bought in July and sold in Nov you lost 30%

If you bought in Nov and sold in Feb you made 32%

If you bought prior to Jun you've basically been going sideways for a very long time.

To me GLD is a much more exciting investment than the countless securities that I've held in the past that either go down only for very long periods or worse yet sideways and don't pay dividends.

May 12 07:28 AM

[oldman:]

would RSI 15 be useful for another time period, more than 15 days?
Or for weekly or monthly?

May 12 10:10 AM

[wengem:]

I was kind of hoping that you would draw the conclusions and I would read them.

May 12 12:51 PM

[RiskReturnO...:]

Squeezing the last 3% out of LQD looks tempting; only concern is that while credit spread could narrow, treasury yield could move up above 3.3% resistance, "canceling" out any gains.

My followers are up 10-12% for past few weeks with long LQD, long TBT trade. This is still the best risk-return optimized way of playing investment grade corporate bonds. Best timing of this trade is wait for 10 yield treasuries to approach 3.0% support, but TBT and LQD as a pair, and participate in the spread compression without worrying about inflation expectations or failed treasury auctions.

May 12 08:44 PM

[dcb:]

It would help if you provided what you thought would be a reasonable entering position considering earnings expectations.

May 12 08:45 PM

[dcb:]

Analysts Turning Bearish on S&P 500 After 14% Rally (Update3)
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By Michael Tsang and Lynn Thomasson

May 11 (Bloomberg) -- The biggest earnings-season rally since 2002 has pushed 34 percent of the companies in the Standard & Poor’s 500 Index above analysts’ price targets for the next year, raising concerns about the pace of the recovery.

The S&P 500 was within 5 percent of the combined price projections of more than 1,700 securities analysts last week after gaining 14 percent since Alcoa Inc. reported first-quarter results on April 7. Caterpillar Inc., the largest maker of excavators, and Citigroup Inc., the bank rescued by $45 billion in U.S. taxpayer funds, are among 170 companies that trade above their average price estimates, data compiled by Bloomberg show.

So far, analysts have resisted lifting price and earnings targets after the S&P 500 surged 37 percent from a 12-year low in March. The combination of falling profit predictions, rising valuations and higher costs for options that insure against losses are raising investor concerns that the rally may have come too far, too fast.

“To expect this to continue to move onward and upward from here would be unrealistic,” said Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management, which oversees $132 billion in New York. “It would be healthy for the market to take a breather and allow some of the fundamentals to catch up.”

With more than a third of the companies in the benchmark index for U.S. stocks overvalued compared with their price targets, the S&P 500’s fair value is 970.21, compared with its 929.23 close on May 8, data compiled by Bloomberg show.

Banks Lead Market

The S&P 500 fell from a four-month high today, losing 2.2 percent to 909.24, as banks said they would sell more shares. The decline was the largest in three weeks.

The index rose 5.9 percent last week, erasing this year’s losses, after results from the government’s examination of banks reassured investors and the Labor Department said the pace of job cuts slowed in April. Financial stocks led the measure’s advance, surging 23 percent.

More than 200 companies in the gauge have risen at least 50 percent since this year’s low on March 9. Prices of almost half the companies in the measure are within 5 percent of the fair value target, according to data compiled by Bloomberg.

The S&P 500’s steepest nine-week rally since the 1930s began as the biggest U.S. banks said they were profitable in the first quarter, President Barack Obama outlined $787 billion in spending and tax cuts and the Treasury unveiled plans to finance as much as $1 trillion in purchases of lenders’ troubled assets.

Lack of Support

“Estimates suggest there isn’t that much further to run because equities are fairly valued,” said Hayes Miller, who helps manage $30.9 billion at Baring Asset Management Inc. in Boston. “Earnings growth for 2009 and 2010 can’t support prices too much higher than where we are today.”

S&P 500 companies beating profit forecasts outnumbered those that trailed by 2-to-1. A majority of companies in each of the index’s 10 industries posted results that beat projections, data compiled by Bloomberg show.

Caterpillar reported 14 times more per-share profit on April 21 than the consensus estimate. Since then, 15 of 19 analysts cut second-quarter forecasts by about 53 percent and 16 reduced their outlooks for the third quarter by 66 percent. No one covering Peoria, Illinois-based Caterpillar boosted estimates, Bloomberg data show.

The company’s 30 percent surge since its earnings release has pushed the shares to $39.64, 25 percent higher than the $31.83 analysts on average say the company is worth.

‘Sudden Jamming’

Nick Heymann at Sterne Agee & Leach Inc. in New York rates Caterpillar a “sell” and expects the stock will fall 39 percent, based on his price target of $24.

“We’re going to have a sudden jamming on the brakes of investors’ enthusiasm for early-cycle stocks when they realize they made a big mistake,” he said in a telephone interview last week. “If you’re not properly positioned in your portfolio, you may find that you go through the windshield.”

Since New York-based Citigroup reported per-share profit that was 48 percent higher than the consensus on April 17, more than 50 percent of the analysts reduced their estimates for the second quarter and half cut their projections for all of 2010, Bloomberg data show.

Shares of the bank surged 35 percent last week, leaving them overvalued by 33 percent, based on the average 12-month price target compiled by Bloomberg.

Starwood Estimates

Of the 17 analysts with estimates for Starwood Hotels & Resorts Worldwide Inc., owner of the St. Regis and W Hotels chains, 13 cut earnings forecasts for the second and third quarters since the company’s per-share profit in the first quarter beat projections by 300 percent.

Starwood, based in White Plains, New York, more than doubled to $22.08 from its low in March, lifting its market value to $4.12 billion. That’s $1.08 billion more than analysts say it is worth, based on price targets compiled by Bloomberg.

Goldman Sachs Group Inc.’s Steven Kent trimmed his profit estimates through 2011 and said on May 1 that “aggressive” cost cuts were behind the results from the first quarter. Kent, based in New York, advised selling Starwood and says earnings only support a price of $11, half its closing level last week.

The 17-month bear market hurt the credibility of Wall Street analysts and strategists who remained bullish during the worst year for stocks since the 1930s.

‘Not Real Good’

They were slow to recognize a recovery, which may force them to play catch-up as stocks climb, said Richard Bernstein, the former chief investment strategist at Bank of America Corp.

“We’re not real good at forecasting the future,” Bernstein, who left last month to start his own money-management firm, said during an interview in New York. “I used to tell everyone that the most-watched, least-important thing I do is the target on the S&P.”

Strategists said the index would rally 11 percent last year, according to data compiled by Bloomberg. It lost 38 percent instead.

Analysts overestimated earnings by an average 13 percentage points in each period between the third quarter of 2007 and the end of 2008. Better-than-expected first-quarter results haven’t prompted them to boost forecasts for the rest of 2009. Instead, they’ve ratcheted down predictions as the first global recession since World War II weakened demand.

Analysts said in March that profit among S&P 500 companies may drop 29 percent in the second quarter and 15 percent in the third before jumping 95 percent in the final three months of the year, according to data compiled by Bloomberg.

Steeper Drops

Now, they expect a 35 percent slide in second-quarter income and a 23 percent decrease in the third. The consensus is for profits to rebound 69 percent in the last quarter, with financial companies accounting for all of the gain.

Analysts project that companies in the benchmark stock index will earn $57.17 on a share-weighted basis this year, data compiled by Bloomberg show. Based on the measure’s closing price last week, investors are paying $16.25 for each dollar of forecasted profit.

That’s in line with the historic average of 16.3 times earnings over the past 128 years, data compiled by Yale University Professor Robert Shiller show. Strategists say stocks are fairly valued, predicting the S&P 500 will end the year at 949, with its companies producing per-share earnings of $47.06.

The estimate represents a gain of 2.1 percent in the next seven months as declining profits push the index’s price- earnings ratio to 20.2. That’s more expensive than any time in the past five years.

Priced In

“The equity market has priced this recovery and then some,” said Barry Knapp, U.S. equity strategist at Barclays Plc in New York. “It looks pretty expensive to us.”

Knapp, the most bearish of the 10 strategists tracked by Bloomberg, says the S&P 500 will decline 19 percent from last week’s closing price, based on his year-end target of 757.

Gains have already pushed the index past projections from Barclays, Credit Suisse Group AG, Deutsche Bank AG, HSBC Holdings Plc and Morgan Stanley. None of the 10 forecasters polled by Bloomberg News has raised outlooks for 2009.

Leon Goldfeld, chief investment officer of the Hong Kong unit at HSBC Global Asset Management, which oversees more than $350 billion, said in an interview on May 4 that it’s “hard to see” enough profit growth to justify higher stock prices. The firm’s strategy will be to reduce its holdings of equities and move into bonds and cash, he said.

Chop and Grind

Options traders are increasing bets the rally is about to end. Futures on the Chicago Board Options Exchange Volatility Index, which measures the cost of buying or selling options as insurance against declines in the S&P 500, are priced above the gauge’s level of 32.05. The premium on VIX contracts expiring this month through November indicates traders are betting the stock index will fall in the next six months.

History also shows rallies from bear-market lows suffer setbacks before climbing. The last time U.S. stocks broke out of a bear market in 2002, a seven-week, 21 percent surge from the trough gave way to a 15 percent drop before the bull market resumed. During the Great Depression, a 47 percent surge after the stock-market crash in 1929 was followed by at least six retreats of at least 25 percent.

“We’re going to be in a very volatile, chop-and-grind type of market,” said Christopher Hyzy, chief investment officer at Bank of America’s private wealth management unit, which oversees $200 billion. He said the S&P 500 may retreat as much as 10 percent as investors focus on the ability of companies to increase earnings to pre-recession levels.

“We’ve been shown that there is a small light at the end of the tunnel, it’s dim but getting brighter, and that’s why stock prices have come this far this fast,” Hyzy said from New York. “Now, it’s all about ‘show me.’”

To contact the reporters on this story: Michael Tsang in New York at

May 13 12:30 AM

[one eye:]

You won't see "show me" until January of 2010.

By then you will have missed 50% of the Markets move. Bull Markets move like Bear Markets move.

This Bear was not started by the public, it was started by the Financials. Armageddon was priced into it. Armageddon is being removed.

May 13 02:33 AM

[SpanglerDavis:]

Instead of the long TBT trade, just buy ATM puts on TLT 4 to 6 months out. At least you have the decay working for you. Tripled my money on the May 105 puts.

May 18 05:30 PM