- Large sell offs in momentum leaders (NFLX, TSLA, AMZN, etc.) are one sign of a possible overall market reversal.
- Link to the article, "Evidence Is Piling Up That The Market Is In For A Downturn." This article contains more specific indicators.
- The economic news from China has been terrible lately. FY2014 GDP growth may be far less than 7.5%.
- China has significant bad loan problems which could lead to a financial crisis as bad or worse than the EU and the US crises.
- Russia's annexation of the Crimea may cause a trade war between Russia and the EU and US with dire economic consequences.
Momentum stocks are infamous for continuing to go up against almost all fundamental measures. They often trade at PEs over 100 for extended periods of time. They are sold to the public as "stocks of the future." They are supposed to be leaders in their areas; and all three of the above stocks are leaders. Tesla Motors (NASDAQ:TSLA) makes perhaps the best electric only car. Netflix (NASDAQ:NFLX) is the pre-eminent streamer of entertainment media, although its competition has been gaining on it. Amazon.com (NASDAQ:AMZN) is the most successful pioneer in online retail sales. All three have distinguished pedigrees; but all three trade at multiples that are virtually impossible to justify by any reasonable means, although many analysts have attempted to do so. Peter Lynch used to call these stocks "nose bleed" stocks. "Nose bleed" valuations were at such high altitudes (multiples) they could give you a nose bleed if you owned them. He usually advised against owning them at all.
However, we have seen the above stocks go up and up and up over the past five years. AMZN has gone from roughly $70 in late March 2009 to a high of $408.06 on January 22, 2014. It has since fallen to an intraday low of $348.60 as of this writing on March 24, 2014 (-14.6%). NFLX has risen from $54.44 on September 24, 2012 to a high of $458 on March 6, 2014. It has since fallen to an intraday low of $368.60 as of this writing March 24, 2014 (-19.5%). TSLA has skyrocketed from about $33 in January 2013 to its recent high of $265 on February 26, 2014. It has fallen to an intraday low of $210.27 as of this writing March 24, 2014 (-20.7%). These are all significant drops for any stock; but they may only be the beginning of losses for the above stocks. Intraday today March 24, 2014, each of these stocks has rebounded significantly; but each is still down significantly on the day March 24, 2014, and on the year in 2014.
Normally investors will see such stocks take hits on bad news. When many of the biggest momentum favorites start to make big moves to the downside at roughly the same time on news which is not stock specific, it is time to consider that the market is turning. When the current bull market is five years old, it is even more important to acknowledge that this may be the case. Of course, there are many more indicators that seem to be foretelling a market turn too. Many of these are delineated in the article, "Evidence Is Piling Up That The Market Is In For A Downturn." Investors should read this to get a more thorough idea of the problems facing the world and the equities markets currently.
The news from China in March 2014 has been nothing short of atrocious. The Chinese March 2014 HSBC Flash Manufacturing PMI came in at 48.1. This is even lower than the seven month low the HSBC Manufacturing PMI hit in February 2014 of 48.5. It bodes ill for March Chinese results. Further Chinese exports for February were down -18.1% year over year; and imports were up +10.1% year over year. These statistics led to a -$23B trade deficit for China for February 2014. The PPI year over year was -2.0% (deflation). This is a sign of slowing or of a possible recession in the near future. Retail Sales for January - February missed badly at 11.8% versus an expected 13.5%. Industrial Production for January - February missed badly at 8.6% versus an expected 9.5%. This data is indicative of very definite slowing. If it persists at all (or worsens), China's GDP growth will be far lower than the national government's estimate of 7.5% for FY2014. Some are already estimating 5%-6% GDP growth.
Why is this so important? If China may grow at least at 5%-6%, isn't that still good growth? For China, it probably is not "healthy" growth. The reason is that China has a lot of troubled loans (local government, private, and corporate); and China will have a lot more troubled loans if its economy slows more. To put this in perspective, if the US made loans with an economy growing at 3% a year, a lot of those loans would go bad if the economy started contracting at -2% per year. If China only grows at 5%-6% per year, this will be relatively the same situation. China's GDP growth was 13% in 2007. In FY2013 Chinese GDP growth was 7.7%. This seems robust to anyone in the US or EU, but it was already -5.3% lower than China's 13% growth in 2007. If Chinese GDP growth slows to just 6%, that will be 7% below the GDP growth for 2007. Many loans that assumed continued 10%+ GDP growth would go bad.
The chart below of China's rapid housing inventory growth over the last 3-4 years (at the same time the China GDP growth has been declining) shows that the Chinese real estate market is in serious trouble.
Prices in China's largest cities such as Beijing and Shanghai are still strong; but they account for only about 5% of total building within China. Prices are falling in 43% of the tier 3 and tier 4 cities. Floor space per capita has reached 30 square meters. This is higher than the level in Japan in 1988, just before the Tokyo market collapsed. The chart below of floor space started versus floor space sold shows the growing gap between the two in China.
The IMF said the ratio of residential investment to GDP reached 9.5% in 2012. This is higher than the peaks in Japan and Korea before their falls. It is much higher than the US ratio before the subprime crisis. The IMF also warned that China is running a budget deficit of 10% of GDP, once land sales are stripped out. The IMF thinks it has considerably less fiscal leeway than many are assuming. China may soon have a full blown financial crisis on its hands on the order of the recent US and EU crises. China may have to write off $4T or even more of bad debts in the next few years. Local government debt alone is officially $2.95T (or unofficially nearer $5T). Much of this debt cannot be repaid because those governments do not have the necessary income streams. They have been rolling it over year after year; and as a consequence it has grown by 67% from the end of 2010 until June 2013 (in about 2.5 years). I and others estimate that 50% to 75% of this debt will have to be written off eventually. Corporate debt and private debt will add further to the amount that has to be written off. China's fiscal crisis may be even bigger than the EU and US crises; and it is seemingly ever more inevitable. China may be able to kick the can down the road for another year or two; but that will only serve to make the problem bigger. It may be better to bite the bullet now.
China is the most noticeable of the emerging market countries; but other countries are in as bad or worse shape. Many are seeing their currencies inflate versus the USD and the Euro (for example Argentina). This is being exacerbated by the cut back in European and US lending to the emerging markets after the recent banking reforms. That has meant that there are fewer Euros and USDs available for those countries to pay their external bills with. It has led to an acceleration of inflation in many currencies; and it is making it ever harder for those countries to afford to buy their imports of such things as energy and food, which are often denominated in USDs and/or Euros.
On top of this, Russia has recently annexed Crimea, until then a part of Ukraine. After the Duma vote in favor of making the Crimea a part of the Russian Federation on Thursday March 20, 2014, the US and the EU are considering more significant sanctions than the minor ones they have already imposed. They have already kicked Russia out of the G8. The G7 will meet in Brussels instead of Sochi for its economic summit this summer. Obama also met with the G7 leaders on March 24, 2014 to discuss how to pressure Russia for the taking of the Crimea. A trade war may ensue.
In addition many are worried that Russia will continue its imperialist behavior toward the rest of Ukraine, other former USSR countries, and its former Eastern European satellite countries. The Ukraine is not a member of NATO; but it was being considered for membership. Other countries such as Latvia, Lithuania, Estonia, Poland, Romania, etc. are all part of NATO; and they are all worried. NATO has to decide what its response will be to any incursion. This uncertainty is upsetting equities markets. Further there is the possibility that Russia will cut off natural gas supplies to the EU as part of the "sanction war" that is brewing. The EU gets about one third of its natural gas from Russia, so this is not a small economic issue for the EU or for Russia, which depends on its oil and gas revenues for its livelihood.
On a technical basis, the overall market is looking troubled too. The charts below of major indices illustrate this well.
The slow stochastic sub chart shows that DIA is neither overbought nor oversold. The main chart shows that DIA is in a weakening uptrend. The 50-day SMA looks like it is about to cross the 100-day SMA going downward. That would be a sell signal. With all of the worldwide negative fundamental economic and geopolitical data recently, that seems more likely to happen than to not happen. On top of that the DIA seems to have put in a double top recently. That is a negative technical formation. In sum both fundamental and technical data indicate that a substantial down move is likely.
The slow stochastic sub chart shows that the SPY is neither overbought nor oversold. The main chart appears to be in a slightly weakening uptrend. The SPY may have put in a weak double top recently. Technically the SPY could move in almost any direction from this point. Fundamentally the data described above, and in the other article cited, argue for a downward movement.
The slow stochastic sub chart indicates that the QQQ ETF is getting close to an oversold state. The main chart indicates that the QQQ is in a weakening uptrend. However, the price line has moved below the 50-day SMA. This is a sell signal. On top of that the recent topping action can be interpreted as a double top or as a weak head and shoulders pattern. Both of these are negative indicators for the QQQ ETF price. Fundamentally the QQQ should fall. In sum a downward move from here is likely.
The slow stochastic sub chart indicates that the IWM ETF is neither overbought nor oversold. The main chart indicates an uptrend. The most recent topping action shows a weak double top. This is a negative indicator. The fundamentals indicate that a move downward is likely. In sum, the IWM is likely to move downward from here.
Overall the technicals and the fundamentals are negative for the above four major index ETFs (for US equities in general). When you add the FactSet EPS estimate of 0.0% growth for Q1 2014, the picture looks more negative. This estimate had been +4.4% on December 31, 2013, so things have been trending negatively since then. In addition the Fed lowered its US GDP growth estimate for FY2014 to 2.8%-3.0% (down -0.2%). Further the Fed indicated a likely 1% Fed Funds rate at the end of 2015 and a 2.25% rate at the end of 2016. Many had still been hoping that rate hikes would be put off indefinitely. Neither announcement was greeted happily by the market. Both the above Fed actions along with the continued tapering of QE3 to $55B/month constitute tightening policy. They should give the market a downward bias.
Investors should think about taking some of their equities' monies off the table. For now it might be appropriate to put the money in T-bills or short-term Treasuries. If investors desire a more permanent move into the bond market, intermediate term corporate bonds may be the best solution.
For NFLX, AMZN, and TSLA, the recent down moves have been considerable. They may see a short-term bounce higher? Or they may just continue to go lower. On a PE basis, each of them has a long way that they can go down. AMZN trades at a PE of 596.36 and an FPE of 83.18. NFLX trades at a PE of 204.70 and an FPE of 51.20. TSLA trades at a non-existent PE (is not yet profitable) and an FPE of 56.74. In other words, each of these stocks is hugely overvalued currently; and each of these stocks will still be far overvalued by normal standards if each company meets its lofty EPS growth goals for the next two years. The FPEs listed above are for the end of 2015. If the US economy and the world economy (if China is any indication) are slowing, it seems likely that these companies will miss their EPS growth goals. Therefore they are that much more overvalued. When overvalued growth stocks start missing their growth goals, they usually fall dramatically, even if they are momentum stocks. AMZN, NFLX, and TSLA all have a lot of room to fall. Each could easily lose more than 50% of its current value within the next year.
NOTE: Some of the above fundamental financial information is from Yahoo Finance.
Good Luck Trading.