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  • Signs That The Market Is At A Top -- But Are We??

    I recently had a conversation with another SA participant debating the fact that the market was, or is about to "top out". When I saw the following list presented by that individual, my first thoughts were that I had seen and debated many of these points individually at one time or another here on SA.

    These same concerns have haunted many investors since the days when the S & P (1550) broke out of its 13 year base period to start a new secular bull market in 2013.

    After reading them once again, I replied and declared that I would gladly rebut all of the 12 items presented showing how, in my opinion, these data points can easily be refuted.

    Please understand that this rebuttal is by no means meant to disrespect the views of that individual. It merely takes the "other side" of these arguments, and in my view provides some food for thought on the state of the equity market as its stands today.

    These same worries have been bandied about here on SA and elsewhere for years now, calling for tops all along the way.

    Here is the list as it was presented in that article, with a headline ----"Signs that the market is at a top "

    1. Retail investors pouring money into stocks & mutual funds- just like they always do before a crash or bear market.

    2 There is a low proportion of bears just like it was before the 1987 crash.

    3. The VIX, the put-call ratio and other major sentiment indicators suggest traders are getting complacent.
    3a. Investors are complacent - many believe the Fed, or their fund manager, will protect them in a worst-case scenario.
    3b. The Fed's policy of keeping rates low encouraged investors to put more money into risky investments with a higher likelihood of going bankrupt.

    4. Fundamentals are being ignored. High P/E ratios, soft economic readings (i.e. GDP and ISM).

    5. Investors have forgotten previous crashes.

    6. Stocks are soaring. New highs are made with regularity.

    7. Greed is at an all time high. When a market reaches the tipping point, investors and traders buy anything that moves.

    8. Margin debt reached record high.

    9. The stock prices of low-quality companies reaches new highs.

    10. The media is bullish.

    11. The Fed withdraws liquidity from the markets but banks are not that willing to lend much capital to businesses.

    12. A sharp rise in IPOs and merger activity are signal the top is near.

    My commentary on each item presented:

    1.Retail investors pouring money into stocks & mutual funds- just like they always do before a crash or bear market.

    Rebuttal

    I would like to see evidence to support that statement. I just don't see that as fact.

    What I can state is that on Feb 28 2015 I highlighted a report From Strategas research,

    investors still appear unenthusiastic regarding equities, putting $26 billion year-to-date into bond funds and pulling $17 billion out of equity funds.

    Updated Gallup results - April 2014

    For many individual investors in the U.S., the Financial Crisis still casts its long shadow over their confidence in equity markets. (That headline refutes Item # 5 'Investors have forgotten previous crashes" )

    Even though the S&P 500 has recovered all its losses from the 2007-2009 drop, barely half of Gallup respondents in their regular surveys on the topic report that they have "Any money invested in the stock market right now - either in an individual stock, a stock mutual fund, or in a self-directed 401(k) or IRA". The exact numbers: 54% reported such ownership in April 2014 (last results) versus 65% in 2007 and 67% in 2002 (all time high).

    Wells Fargo /Gallup investor poll August 2014 reveals

    Amid a strong bull market that drove the S&P 500 up 30% in 2013 and has continued to produce gains, fewer than half of U.S. investors -- 41% -- say that if given an additional $10,000 to save or invest, they would put it in the stock market. Just over a third, 36%, would hold it in cash, while 20% say they would purchase a CD with it.

    The cautiousness seen in investors' choices of where to put a spare $10,000 is mirrored in a separate question asking investors how they feel about investing their own money in the market. Nearly half describe themselves as extremely or somewhat nervous about doing this; another 38% are a little nervous, while just 16% are not nervous at all.

    These comments also refutes Item # 5 ('Investors have forgotten previous crashes" )

    Recent AAII sentiment survey shows that 25% are bullish.

    Unless someone can convince me that there has been a an enormous "sea change" in the investment psyche of the general public, the data presented clearly shows multitudes of investors aren't interested in this bull market . I've stated that since 2013.

    2. There is a low proportion of bears just like it was before the 1987 crash.

    Rebuttal

    First. I can's speak to the number of bears, maybe they just don't bother to report anymore. At this stage of the game they simply wont admit being bearish. I do know that many of the 'bearish" authors that I debated for over 2 years now are gone. I believe because they simply can't take the heat after a 650 point rise in the S & P. Now they watch the thoughts and ideas from those that refuted the bearish rhetoric and see that those bullish comments have indeed worked out. What are they going to present now ?

    One thing for sure, we can clearly see that for the S & P recording all time highs, the sentiment out there is far from euphoric.

    From Bespoke Investment Group - May 14th

    Bullish Sentiment Drops to Lowest Level in More Than Two Years

    (click to enlarge)

    It didn't just happen lately, its been prevalent throughout this bull run

    And now the May 21st AAII sentiment survey shows only 25% are bullish.

    From Bespoke regarding that report

    This morning's American Association of Individual Investors (AAII) survey of investor sentiment showed the bulls declined again, to their lowest level since April 19th, 2013: 25.2. This marks the 12th week in a row that bulls' share has come in lower than 40, and the third in a row it's been below 30.

    No euphoria, no "everyone is all in and throwing caution to the wind" mentality exists, even as the S & P is marching to all time highs. To the contrary, the masses do not acknowledge or believe what is happening in the equity market. .

    Second - Lets look at 1987. The scenario back then was inflation and overheating became a concern due to the high rate of economic and credit growth. The Federal Reserve rapidly raised short term interest rates to temper that inflation,which dampened some of stock investors' enthusiasm. As interest rates continued to rise, many institutional money managers scrambled to hedge their portfolios at the same time. On October 19th 1987, the stock index futures market was flooded with billions of dollars worth of sell orders within minutes, causing both the futures and stock markets to crash. In addition, many common stock investors attempted to sell simultaneously, which completely overwhelmed the stock market.

    Shortly after the crash, the Federal Reserve decided to intervene to prevent an even greater crisis. Short-term interest rates were instantly lowered to prevent a recession and banking crisis. Remarkably, the markets recovered fairly quickly from the worst one day stock market crash.

    Now I ask - Is that interest rate scenario present now? Is Inflation out of control now with an economy that is overheating?

    This isn't 1987 in any way shape or form.

    3. The VIX, the put-call ratio and other major sentiment indicators suggest traders are getting complacent.

    Rebuttal

    Back in June 2014 I penned a blog post which among other things suggested the secular bull market was still underway with "plenty of runway left" and cited that the "Low Vix" that we are witnessing was of no concern.

    The naysayers now say that perceived risk as measured by the VIX is now "artificially low" and bound to "return to normal" any day now. It's just another argument that is being presented (almost daily) now, simply because many of the "old" arguments from that crowd have been disproved -- Remember the "fed could never taper" warnings and "equities would in fact crumble" when tapering begins.. So, now the story is wait until the "punch bowl " is pulled away altogether... and the VIX is too low.. so surely something has to give.

    It was nonsense then and that along with their "Vix" argument is nonsense and more "noise" now.. and here's why:

    My view is what we are seeing now in the Vix is normal. Its just many are still scared and reflect back to an upsetting market experience when the Vix spiked and spent a lot of time at increased levels.. It was a nightmare that many are still reminded of.. and its understandable.. But that really isn't "normal" .....

    However, in more benign, boring environments, such as where we are now and where we are heading, the VIX has spent years in low double digits (for example, 2003 to 2007, and 1992 to 1996). Today, even with the VIX at 11-12, the 12-month forward curve has it much higher, near 19%-so investors continue to expect volatility to rise again, and are pricing this into risky assets such as equities. What if the reverse were true? (Which i suggest is unfolding before our eyes) What does that do to pricing of equities.. ? The naysayers hanging their hat on that argument may be in for yet another surprise..

    So far those thoughts and the action in the Vix has proved the theory that what we are witnessing in the low Vix environment is in fact NORMAL and NOT the other way around.

    Finally, an interesting analysis with graphic presentation on why the VIX can stay low for Years.

    3a. Investors are complacent - many believe the Fed, or their fund manager, will protect them in a worst-case scenario.

    Rebuttal

    I believe that is more opinion than fact. Many Do not trust the market or anyone else for that matter give the financial crisis that is still fresh in the minds of many. ( look at the Gallup surveys presented)

    3b. The Fed's policy of keeping rates low encouraged investors to put more money into risky investments with a higher likelihood of going bankrupt.

    Rebuttal

    For those that had the wherewithal and good fortune to use the "signal" that the Fed gave early in the recovery regarding interest rates and QE, the results are 'life changing".

    To suggest that people will now go bankrupt due to Fed Policy is simply an allegation that investors are too stupid to protect gains and dovetails with the cries that investors who HAVE increased their wealth during this bull market "will give it all back".

    Nothing could be further from the truth. It is the cries of the frustrated bear crowd and their sour grapes attitude, simply because they did not take advantage of one of the greatest signals to buy equities in one's lifetime.

    From a blog post November 26 2014

    I have consistently argued that the current bull market could be one of the biggest we will witness in our lifetimes. Often calling it the "opportunity of a lifetime" , a 'game changing life event" for those that chose the bullish equity path in the last few years. That stance has continued to provoke the ire of many who simply don't wish to embrace this market. Sadly as I have stated before, they have truly been left behind.

    The crowd that continually doubted the FED approach and obsessing over it's policy was totally wrong footed and has cost them a fortune.

    4. Fundamentals are being ignored. High P/E ratios, soft economic readings (i.e. GDP, ISM)

    My missive from May 16th, speaks to why investors need to look at the "Global" picture,

    Why ? For one simple reason, the stock market is doing just that.

    From my thoughts of this past week. The danger of taking a data point "headline" and running with it.

    Last Friday's Industrial Production report for the month of April showed a decline of 0.3%, which was notable in that it represented the fifth straight monthly decline in this indicator.

    So what does this tell us about the current period?

    For starters, Industrial Production measures activity in the manufacturing sector, and that sector's weight in the overall economy has consistently declined over time. IP covers activity in the manufacturing, mining, and utilities sectors, those sectors have seen their overall weight in GDP almost cut in half from a peak of 32% in 1953 down to 16% in 2014. That is food for thought and demonstrates the danger of over reacting and running with a "headline".

    So while weak exports due to the strong dollar and the crash in energy prices have hurt the manufacturing sector, the rest of the economy looks to have fared a little better.

    This can be further illustrated in the recent moves in the ISM Manufacturing and Non Manufacturing indices. While the ISM Manufacturing index has seen a significant decline from 57.9 down to 51.5 in the last six months, the ISM Non Manufacturing index is actually up over that same time period (56.9 to 57.8)!

    Examples of what should be done. Interpreting data points, and weaving them into a global picture to form a true background to make investment decisions.

    Finally, a bit of philosophy when it come to valuing this market.

    I will add to that philosophy, my own thoughts and ideas of evaluating the equity market based on the present environment we are in as presented in my missive dated May 20th.

    That article debunks the two favorite metrics used by the bears to state their over valuation case. Cape Shiller ratio and the Buffet "Market cap to GDP" ratio. The commentary in that blog post is critical to understanding the importance of looking under the hood of data points rather than running with a headline to form a market strategy.

    Not many are paying attention to historical norms regarding Treasuries and Inflation. I suggest that is what many are 'missing ' when they take the over valued headlines at face value and ignore the present investing environment, then start throwing around the High PE ratio argument.

    Allow me to throw out some additional thoughts with comparisons to historical norms.

    Now lets take a look at the environment as it exists today and compare it to "history" to help determine the markets valuation.

    Since 1960, Treasury yields have ranged from 15.7% in 1981 to 1.4% in 2012, with anaverage of about 6.5%. Benchmark 10-year Treasury yields are now currently at 2.20%, which is some 65% below normal. When you plug these metrics into the "Fed model," the S&P 500 is 59% undervalued relative to Treasury bonds, using trailing P/E's. While I wont go that far with valuations, I wont buy this "wild overvaluation" theme either

    Same story with inflation. Since 1960, the core Personal Consumption Expenditure (PCE) index-the Fed's preferred measure of inflation-has ranged from 10.2% in 1975 to 0.9% in 2010 on a year-over-year basis, for an average of 3.3%.

    Core PCE is currently running at 1.3% through March 2015, 60% below normal. Using the so-called "Rule of 20" methodology, below-trend core inflation at current levels would translate into a forward P/E of about 18.7 times, which suggests that stocks are about 8 and 12% undervalued, respectively, on estimated 2015 and 2016 EPS.

    In summary, over the past 55 years, the average trailing P/E for the S&P 500 is 16.5 times, with average benchmark 10-year Treasuries yielding 6.5% and average core PCE inflation at 3.3%.

    But with interest rates and inflation now well below normal at 2.20% and 1.3%, respectively, I am comfortable targeting above-average P/E's in the upper teens on forward earnings. So far the market is agreeing with that assessment. No, this it isn't wild euphoria that we are witnessing.

    Stocks are no longer as dirt cheap as they were at the bottom of the Great Recession with an 11 P/E. And they shouldn't be after the run we have just witnessed.

    BUT, given the relatively benign levels of both interest rates and inflation, particularly when compared with the return potential of other asset classes, such as cash and Treasuries, equities offer moderately attractive valuation prospects over the next 12 months or so even at S & P 2120.

    5. Investors have forgotten previous crashes.

    Rebuttal

    Addressed in Item # 1

    and more information from a blog post on April 11th

    Interestingly, according to a recent Bank of America survey, investor sentiment toward American stocks is at the lowest point it has been since 2008. Some investors are skeptical of American stocks because they are more fully priced than some companies in Europe or some companies in Asia. Everyone is all in ?, there is euphoria everywhere ? -- I think not.

    6. Stocks are soaring. New highs are made with regularity

    Rebuttal - This argument actually favors the bullish view. Strength begets strength and new highs are not at all a sign that this is "the end" and it has to be THE "top". If so, that could have been said when the S & P broke out of its 13 yr base pattern @ 1550 in March 2013. Taking that as a sign of THE top, an investor would have now sat out some 600 S & P points.

    My thoughts on September 1 2014 when then the headline on my weekly blog was S & P at new highs, should we be afraid?

    One trademark of true bull markets is new all-time highs. The S&P 500 made 45 new all-time highs in 2013 and has added another 30 so far in 2014.

    So if new highs are a bad thing and a sign that the market is at a top then one could have cried that 75 times and as of 9/1/14 would have been incorrect 75 times since Jan 2013 ! And now we can add more to that number here in mid 2015.

    Don't be fooled into thinking new highs are bearish.

    Here is what "new highs"represent - Josh Brown - The reformed broker Jan 2015. Please read this slowly and carefully

    Just reading or hearing the term itself engenders a certain kind of hysteria in people. It suggests that things are about to tip the other way any second, as we all carry within ourselves a cognitive defect known as the Gambler's Fallacy. We innately believe that random occurrences are meant to balance out over short periods of time. That ten straight coin flips landing on heads virtually assures that a tails flip will be next - despite the fact that the next flip is its own event and nothing that came before it matters. That the roulette wheel "shouldn't" be able to land on black or red more than five or six times straight - despite the fact that it most certainly can and will.

    It is tempting to hear about previously unheard-of prices for individual stocks and to reflexively declare that they are due to tip back over and bring order to the chaos they've wrought in our perfectly ordered mindscape. If only the world worked this way, predictions would be a snap - anytime we saw something unprecedented take place, like a stock trading at prices it had never seen before, all we'd have to do is bet the other way! But, in fact, behavior like this would quickly wipe our capital out, completely and permanently.

    There is more meaning in an all-time high than meets the eye. This isn't just a data point or a plotted roadside rest stop on the open highways of chartdom. This is a coronation of sorts.

    When a stock hits an all-time high it means that people were willing to pay a price that no one before them has ever paid.

    It means that no one has a loss in the stock or is "waiting to get back to even so they can sell".

    It means that a host of people who had been waiting for that pullback to get in are now ripping their own skin off in aggravation.

    It means that it is the new favorite stock of those who are long, one that they will not easily part with because it is now "one of their winners" and it "has been good to them".

    And so while our DNA and 100,000 years of evolutionary programming may lead us to believe that a new all-time high is a precarious perch and presages an imminent turn in the other direction, it isn't ever quite that simple. Many new all-time highs are merely stepping stones toward the next set of new all-time highs, after all.

    7. Greed is at an all time high. When a market reaches the tipping point, investors, traders buy anything that moves.

    Rebuttal

    I don't believe there is anything that can factually support that statement given what I have demonstrated in the comments earlier that there is simply no euphoria , parades or fanfare as the market marches higher.

    This would appear to be an 'opinion" rather than fact. As demonstrated hew highs are not a 'bad" thing.

    8. Margin debt reached record high.

    Rebuttal

    This has been the cry of many naysayers for quite some time. This is a prime example of taking a "headline" and running with it , rather than looking at what is "under the hood" .

    Articles From Deutche Bank and the Reformed Broker , Josh Brown

    9. The stock prices of low-quality companies reaches new highs.

    Rebuttal

    Since when do low quality issues represent and speak for the entire stock market. There is and always will be speculation among traders in low quality issues from now until the end of time. Bull markets, bear markets and in between.

    Conversely the PE ratio of the Dow 30 components currently stands at 16, based on 12 month trailing earnings. I suggest they represent a tad more about the equity market than the low quality names that traders chase their tails with every day. I'd rather discuss AAPL and some of the other dow components and others that offer value, dividend growth and a path to building wealth over time. I'll let the others deal with the low quality nonsense that will bankrupt one over time, while they insist they are beating the "market".

    10. The media is bullish.

    Rebuttal

    Are there facts or an abundance of articles or link that can be represented ? Once again, This appears to be an "opinion"

    I find that if the market is going up the media is bullish and the "Dow is going to 20,000". When the market turns south then the stories are for "Armageddon". These folks are there to accentuate the headlines and are hardly an indicator of anything.

    11. The Fed withdraws liquidity from the markets but banks are not that willing to lend much capital to businesses.

    Rebuttal

    From my blog post update on April 18th

    On the Economic Front ;

    One of the biggest handicaps facing the recovery has been the lack of access to real estate credit. But on a trend basis over the last 13 weeks, real estate loans at commercial banks have jumped at a 7.3% annual rate-the fastest pace since the beginning of 2009. Commercial real estate loans have been growing at a double-digit rate in Q1, suggesting new developments will be coming in over the next couple of years. But even residential has picked up to a 5.6% annual rate from below zero at the start of the year, the most in over two years.

    From my blog post on Feb 14th,, I mentioned how Banks were starting to lend

    Over the past year, banks have begun to use their reserves to expand their lending activity. Banks are more willing to lend, and businesses are more willing to borrow: Commercial and Industrial Loans are up 13.7% in the past year, and they have increased at a nice 15.1% annualized pace in the past three months.

    and showed this chart from the Fed reserve which is now updated to include April 2015 data

    (click to enlarge)

    From a recent Fed Reserve report dated may 15th commercial and industrial loans for all US commercial banks increased 11.7% in the week ending May 6, 2015-compared to a year earlier. This segment has been growing at more than 10% for almost a year now.

    12. A sharp rise in IPOs and merger activity are signal the top is near.

    Rebuttal - IPO & Market tops

    Perhaps this article says it all about IPO's and market tops. Alibaba, September 2014 , when many Media pundits suggested the market topped coincident what the BABA IPO

    S & P 500 on September 16, was 1998 , today 2110 so it appears 1998 wasn't a top.

    More from the media in October 2014 , and then there is the Business insider version of the market Top story.

    This debunks the IPO and market tops theory along with the media bias whether bullish or bearish as pure nonsense

    Rebuttal - M & A activity

    Might M & A activity signal that companies vie other companies as undervalued ? Might the outlook that company directors are looking at increase their confidence to delve into more deals ?

    Might it be that U.S. targets were attractive to buyers seeking to deploy cash and take advantage of low interest rates as well as the perceived safety of investing in the United States.

    2014 was a robust year for M & A , was that the top ? Clearly it wasn't.

    Any references to 2000 or 2007 and highs in M & A activities in those time frames, in my view have no merit. This isn't 2000 nor 2007. Of course that is a topic for another article.

    I insist that investors who believe any similarities between the present environment and those two years and have positioned themselves looking over their shoulder for the next crash have been fooling themselves.

    Summary & Conclusion

    There certainly can and will be corrections, some of which may be deep and frightening, and I have mentioned that possibility over and over. These are "normal " events in the scheme of bull markets and investors need to be aware and understand that.

    However, the Long Term uptrend is still in place. We are in a secular bull market which I have stated here for quite some time now..

    Many don't like the "secular bull theme" that I talk about and state their opinions like parrots that this fact presents no value in outlining a strategy for investing in equities. I beg to differ.

    Recognizing and establishing a backdrop that an investor is operating with, is the first step in preparing a profitable strategy.

    The detractors like to cite "this and that", running like chickens without heads parroting every headline and following that up with a knee jerk reaction that is simply a self defeating strategy that history has shown - doesn't work. Yet they disdain the secular bull story as meaningless. It is in one word - Laughable .

    Don't believe that ? - think again. Look at the investors that ignore the market backdrop, without a strategy that dovetails with that backdrop and you'll find one that has "talked "themselves out of profits by listening to the thoughts that are presented by the pundits that shout the next headline.

    'Bonds are telling us something" , the "debt markets are flashing warning signs". They call for tops and recessions and market crashes, yet when it doesn't happen they simply move the date down the road .

    Those are indeed the "morally bankrupt" that don't look "under the hood" of the headlines they are promoting. Instead they chase every data point in a feeble attempt to paste together a strategy. Instead of paying attention to what "the market price action" is telling them.

    Conjuring up deflation one day then warning anyone one that listens that we are now on the cusp of inflation. That mentality brings about the wishy washy, top calling, fed obsessed approach that is in no way shape or form an investment strategy.

    I'll leave everyone with this oversimplification,

    For the moment, corporate profits are at record highs, in nominal and real terms, and in relation to GDP, and the "classic precursors of recession", tight money, high real interest rates, and a flat or inverted yield curve are so far completely absent.

    All are entitled to their opinions for sure. My message has been consistent in that I believe we are in a secular bull market. I will repeat once again to the dismay of my detractors that we have not seen the highs on the S & P. And I have maintained that stance since my appearance here on SA in early 2013 ( S & P 1500 )

    When conditions warrant a change , then a change in my stance will also be made, as I am not a "Perma anything". Until then the best approach is to avoid those that are all "rhetoric" and "no plan".

    Best of Luck to all !

    May 28 2:43 PM | Link | 17 Comments
  • May 23-- New Highs For S & P /DJ Industrial Avg., Transport Avg. Still Lags.

    For months, many (myself included) have been highlighting and waiting for the eventual break-out (up or down) from the sideways consolidation pattern that had tightened its grip on equities, and many believed that when it came, we would get a high-volume explosion to propel us away from the mire.

    Instead, the only way I can really describe the market action after the S & P broke to the upside is that it, too, has been anticlimactic. I am not at all dismayed by that. However, the "traders' look at this and cite the 'thin " volume (here we go with the 'light volume" worries). with no BIG follow, thru shake their heads, and aren't convinced of anything.

    But, In my view, its just more of the same, yhis has been the character of this entire bull market run and how things have unfolded along the way. It's not a wild breakout with fanfare and blowing horns. A wild breakout on heavy volume might well have signaled buying exhaustion at an intermediate top. The fact that it don't happen that way is well, business as usual.

    So, progress is progress, after all, and while the move hasn't impressed the pundits (that's fine with me ), that does not mean we cannot still see the internal energy of the market released in a slow and steady manner.

    So, unless we fall back into the sideways mess, I remain optimistic and will gladly take boring profits over exciting losses any day.

    Of note while the DJIA and the S & P tagged new highs on Monday, the bond market sold off heavily. The thought that the bond market will take down the stock market didn't work that well on Monday.. In my opinion the bond market isn't telling holding the "keys" to equity performance. I have said it before " The bond market isn't telling us anything."

    I mentiond this on April 11th , just before earnings season began

    A "Key" for the market's next move ?

    Industrials, Technology and Financials are three cyclical sectors that have held the S&P back recently.

    I am watching the price action in these sectors for they will surely be needed to help the S & P lift to the upside.

    Financials and Technology are now involved in this recent upswing and in fact leading this move higher. Take a look below on the earnings scorecard and it's no wonder why they are moving higher.

    NASDAQ Financial Index has broken out to the upside, surpassing the previous high made in '07. Many portfolio managers are of the opinion that the Financials are likely the only value sector currently.

    Corporate Earnings (Data gleaned from Bespoke Research)

    Nearly 2,400 companies have reported earning since the Q1 2015 reporting period began on April 8th. For all companies that have reported across sectors this season, 60% have beaten consensus EPS estimates, while 49% have beaten revenue forecasts.

    The earnings beat rate is about inline with the historical average, while the revenue beat rate is about 10 percentage points lower than the historical average.

    That's a negative for corporate America as we enter the middle of 2015, that the market is now wrestling with.

    In terms of earnings beat rates, the Energy and Materials sectors have seen the weakest beat rates, while Technology, Consumer Staples and Consumer Discretionary have the strongest beat rates.

    Regarding revenues, Energy, Materials and Utilities have the worst beat rates, while Technology and Financials have the best.

    The Financial sector stands out because its revenue beat rate is strong while its earnings beat rate is weaker than market average.

    Health Care stands out as well with both solid earnings and revenue beat rates.

    I'll add - In my view, Healthcare related stocks should be an oversized weighting in an investors holdings. After all, these companies aren't subject to how many widgets are produced, how many homes are built, cars manufactured and the like, consumer whims ,etc., etc. Yet many disdain the large cap biotech growth companies that are a integral part of the healthcare sector.

    A breakdown - S & P 500 companies vs ALL companies reporting

    2,400 companies that have reported versus the 423 S&P 500 companies that have reported. The earnings beat rate for S&P 500 specific companies is much higher than the earnings beat rate for non-S&P 500 companies. For all companies that have reported, the beat rate is 60%, but it's 67% for just the S&P 500 companies.

    A reason to look at large cap healthcare ----

    80% of Health Care companies in the S&P 500 have beaten EPS estimates, while the beat rate is just 62% for all Health Care companies. I reiterate my bullish stance on companies like CELG & GILD

    The spread is the same for the Energy sector - 72% of S&P 500 Energy stocks have beaten EPS while just 50% of all Energy stocks have beaten EPS. So one can conclude that the large cap oil names is another place to look for opportunity. OXY, CVX, XOM will also offer good yields.

    Interestingly, there is virtually no difference in the earnings beat rates for S&P 500 and non-S&P 500 stocks in the Tech and Consumer Discretionary sectors.

    Overall, the Health Care and Technology sectors have posted the healthiest results so far this season.

    Note that the reverse is true on the Revenue side of things. The "beat rates for S & p 500 names is lower than all companies reporting., This makes perfect sense since the multinationals in the S & P 500 were affected by the Forex issues with the rising USD.

    The Economy

    Last Friday's Industrial Production (NYSE:IP) report for the month of April showed a decline of 0.3%, which was notable in that it represented the fifth straight monthly decline in this indicator.

    There have been plenty of other periods where we have seen such extended declines, all seemingly precursors to a recession. All in all, IP in the current streak is only down 1.0% from its high, whereas in each of the prior streaks IP was down a median of 6.26%

    So what does this tell us about the current period? While the relationship between five month declines and recessions is alarming, there are a number of important caveats.

    For starters, Industrial Production measures activity in the manufacturing sector, and that sector's weight in the overall economy has consistently declined over time. IP covers activity in the manufacturing, mining, and utilities sectors, those sectors have seen their overall weight in GDP almost cut in half from a peak of 32% in 1953 down to 16% in 2014. That is food for thought and demonstrates the danger of over reacting and running with a "headline".

    So while weak exports due to the strong dollar and the crash in energy prices have hurt the manufacturing sector, the rest of the economy looks to have fared a little better.

    This can be further illustrated in the recent moves in the ISM Manufacturing and Non Manufacturing indices. While the ISM Manufacturing index has seen a significant decline from 57.9 down to 51.5 in the last six months, the ISM Non Manufacturing index is actually up over that same time period (56.9 to 57.8)!

    When oil prices started declining late last year and the dollar started rising, it was widely expected that some areas of the economy would benefit while others lost, and the action in the ISM indices clearly illustrates this.

    That being said, I think it's way too early to extrapolate the current five month streak of declining IP and say it is the beginning of a recession. I'll be called a 'cheerleader " and a perma-bull for that statement, BUT I don't see other evidence or data points to suggest the economy is ready to totally roll over.

    To that end, Housing starts surprised with a big surge for the April Numbers. Not a huge surprise to those who were hanging their hats and theories that the poor "Starts' in the March period were hampered by weather. This report surely lends credence to that theory.

    Building permits rose more than expected in April, largely reflecting the normal volatility in the multi-family sector. Single family permits, the key figure in the report, rose 3.7% (to the highest level since December), reflecting a further recovery from weather-related weakness in the first two months of the year. Permits were higher in all four regions

    +7.1% in the Northeast, +1.0% in the Midwest, +3.1% in the South, and +6.0% in the West.

    You should be aware that the housing "starts" data can be unreliable at times, that building permits are reported much more accurately than starts, and that April construction figures were expected to reflect a further recovery from bad winter weather. However, the large jump reported in permits was eye-popping.

    Economic data that came out on Thursday was weaker than expectations. Initial Jobless Claims were a bit higher than expected, Existing Home Sales a bit softer than expected ( note that it was to less inventory, not demand) and May US Markit PMI Manufacturing data came in at 53.8 vs. expectations looking for a 54.5 print. Nothing earth shattering here.

    Globally

    We can now add the Japanese economy to the list of positives from the Eurozone that I reported last week. 1St Quarter GDP there rose at a 2.4% annualized rate, beating expectations.

    The Technicals -

    Despite the market being in drift mode for the past nearly three months, and a 150 point trading range for the past seven months, the bull market continues. The wedge pattern shown below has been broken to the upside, but as stated earlier not very convincingly. Medium term support remains at the 2085 and 2070 pivots, with resistance forecasted and pegged @ 2131 and 2198 pivots.

    However before we get too carried away here, a test of support and the possibility of testing the 2040 level on the S & P may be in the cards. If we do drop and test support levels, I believe we can see new highs develop down the road.

    After highlighting the negative divergence that the DJ Industrials has shown for a while now, I would be remiss if I did not comment on what the situation looks like today.

    That is because the Transports did violate the 8580 support level that I penciled in back in April.

    I was prompted by a fellow participant here on SA to check out the action in the transports versus the recent moves in WTI.

    I came up with the following:

    DJ transports on Jan 2 was 9098, today 8500 down 6.5%

    WTI (from EIA data) Jan 2 $52.72 now $59.8 up 13% and if you look at when oil cratered in the 4th Q '14 from $93 down to $53 the transports traded in reverse of that move and rallied from 8496 to 9098

    So it does appear traders are NOW fixated on WTI when valuing the transports. That wasn't the case in early 2014 when the DJ 20 rallied from January 1 (7287) to September 1 (8496) or 17% while WTI on January 1 was $92 and on September 1 was $93 , and during that time frame WTI traded up to $107

    A totally different mindset - OR - are transports just being re-assessed after the big upward moves in 2013 (38% ) and 2014 (25%) that I've mentioned in past missives.

    Very interesting for sure and I don't see the transports caving the entire equity market as other sectors have taken over as leaders.

    Crude Oil

    Plenty of the cries (again) for 'oil " debt issues to rear their ugly head. Of course the first sign of any weakness like we saw earlier in the week gave a shot of adrenaline to the folks that are calling for oil stocks to be sold. I might add it's the same voices that called for panic selling in the sector at the beginning of the year. That was just about the same timeframe when many savvy investors were putting energy names IN their portfolios.

    The Technical side of the story ---

    My take -- If any weakness presents itself it is merely the fact that Crude oil is simply consolidating a 40% move off of the lows. There is nothing "magical " or 'telling" about that development.

    & On the fundamental side ---

    I have always maintained, that many analysts seem to get the demand side of the equation wrong. The headline that the Saudis just exported crude at a level not seen in 9 years, and this report about a Chinese deman surge seems to add more strength to that side of the story.

    For those who like to track the "whales" when it comes to investing, here is an interesting position just added by one of the best -- Seth Klarman

    "New Stakes" from his recent 13f filing:

    Pioneer Natural Resources: PXD is a fairly large (top-five) holding - It's 8.70% of his US long portfolio stake established this quarter at prices between $135 and $167. The stock currently trades well within that range at $155. For investors attempting to follow Baupost, PXD is a good option to consider for further research.

    I bring up this stock because it seems many "Short sellers" have ramped up their rhetoric following in the footsteps of Mr. David Einhorn and his recent presentation dissing the U.S. fracking industry. It's simply more pundits acting like parrots and attempting to mimic his ''call".

    While I have the utmost respect for Mr. Einhorn and his accomplishments, I am always wary when a public presentation is made by a "short seller". Of course these "public spectacles" are always done AFTER their position is in place.

    I have owned PXD in the past, suggesting purchase in the $175 - $180 level in 2013. It advanced to the $230 level, and of course like all other E & P companies in the Oil sector succumbed to the precipitous drop in Crude.

    So while many are shorting here along with Einhorn in the $150 area it will be interesting to see how this plays out. I believe the 'short " story is flawed and IF I had to pick a side I would be leaning to the "Long" side of this argument. Knowing full well that Mr Einhorn will be back to toot this horn again on the state of the U.S. oil fracking industry and perhaps put more pressure on these stocks.

    On the one hand we have someone quietly building a position in what could be seen as an undervalued situation. While the other side is making public presentations after establishing a position on the "short side" to ramp up the negativity and sell the "agenda".

    As always, be wary of what a "short seller" is "selling" .

    Alibaba - BABA

    I've been a supporter of this story for a while, specifically mentioning the shares last week

    Alibaba - - has broken it's recent price downtrend when the price jumped from $80 on its latest solid earnings report. It's now up 10% since then, and I believe we are in the first inning of this game. I am involved for the Long Term, the shares look poised to trade up to the $90 -95 level.

    That level has been achieved with a close this week @$93. I am increasing my short term price target to $96- $98. BABA is part of my 2015 portfolio "Ideas" playbook.

    It's wise to keep looking at situations that have merit and don't marry the fact that we are at all time highs to a strategy that stops looking for those opportunities.

    Best of Luck to all !

    May 23 9:10 PM | Link | 6 Comments
  • "Cape Shiller PE", "Buffet's Market Cap To GDP Ratio" - Is The Equity Market Overvalued ?

    Oh, the "overvaluation" headlines, they have been, and continue to be everywhere.

    Lets take a look at two of the most popular "overvaluation" metrics that have been presented by some market participants for quite some time now.

    It's time for me to once again dispute the utter mention of the CAPE Shiller as a tool for valuing the equity market.

    Cape Shiller - CAPE (Cyclically adjusted PE)

    Adherents of CAPE were telling anyone who would listen that US equities were as much as 40% overvalued as of July 2009, some 12,000 DJIA points ago. It is THE metric the bears favor, and have been misled by for years now.

    For the past 25 years, the Shiller ratio's signals have been almost uniformly wrong. Since 1989, the S&P 500 has multiplied eightfold, while total returns, including dividends, have increased the value of an average equity investment 12 fold.

    Investors who followed Shiller's methodology, however, would have missed out on almost all these gains. For the Shiller price-earning ratio showed the stock market to be overvalued 97 percent of the time during these 25 years. Even during the two brief periods when the Shiller ratio was below its long-term average - in early 1990 and from November 2008 to April 2000 - it never sent a clear buy signal.

    Here is why it has been and always will be wrong for use as a tool in valuing the stock market.

    The Shiller CAPE , is a cyclically adjusted PE ratio that takes the trailing ten years worth of data in the hopes of smoothing out the expansions and recessions over the course of the cycle.

    Here is an example that many of us lived through and can relate to.

    Corporate earnings over the past decade have clearly been negatively influenced by three, once-in-a-lifetime events: the bursting of the technology and housing bubbles and the Great Recession. That the S&P 500 is currently priced near its all-time record high of 2,125 implies average trailing 10-year earnings of about $78 per share using the Shiller methodology.

    But the S&P 500 actually generated earnings of $113 per share in 2014, and the estimates are for $123 in profits for 2015. So it appears that the Shiller P/E intentionally underestimates earnings by about 50%, because its variables fail to smooth or normalize earnings to account for these cyclical troughs.

    Despite the devastating collapse of the housing market and the Great Recession, the S&P 500 has doubled over the past decade. But just as it has done for 25 years the CAPE's inflated relative valuation signal would have kept investors OUT of the equity market, depriving them participation in one of the greatest value creating eras in stock market history.

    The CAPE assumes a normal business cycle. I don't believe I will get much of an argument from anyone when I state that the period from 2007 thru 2009 was anything but normal. Because of that fact, the mid cycle recovery is going to be much longer than your "typical' business cycle.

    When someone mentions CAPE Shiller as a tool to value the stock market, RUN, and don't look back.

    Another favorite of the naysayers is the constant quoting of Warren Buffett's favorite stock market valuation tool,

    ""The market capitalization to GDP ratio.""

    Now I don't mean to dismiss Mr Buffet and his thoughts on this approach to the equity market. But, I believe other factors now make this method of valuation questionable. However, many still staunchly use this tool to state the market is in fact overvalued.

    Missive from Cumberland advisors; (With my thoughts thrown in)

    The longer-term trend level of S&P 500 value to US GDP is about 95%. The current level of the S&P 500 is about 105% of GDP. So at first view it would appear that the US stock market is richly priced, but not by very much.

    But history suggests that "headline' type of analysis may not be really complete. The range of about 35 points from peak to trough in the ratio of stocks to GDP has held roughly constant for the last century.

    The 1929 high was an extreme overshoot. The World WarII-era, 1942 low was an extreme undershoot; it occurred after Pearl Harbor and before the Doolittle bombing raid on Tokyo. So at today's 105% we are not much above the range.

    But something else has happened since the 1982 low. The foreign-sourced profit share of American corporations has risen from 10% to 30%. Thus an additional 20% of profits now being earned by American corporations originates from their activity abroad.

    However, US GDP does not include the foreign GDP that is the source of that additional 20% profit share. In other words, our domestic GDP generates only 70% of profits; thus using GDP alone to value the stock market is ignoring the growing foreign GDP that has become very significant.

    What can be inferred by that presentation?

    The Negative story ---

    Maybe the current level of stock prices is forecasting that the profit share from foreign sources is going to decline abruptly, while the domestic share is not going to grow.

    That is possible, but I do not see any forces in place to disrupt earnings to that magnitude to make it happen. Maybe the taxation of American corporations is about to go up significantly so that after-tax profits will decline. That is possible, but is that really likely ? I don't think so. We have the highest Corporate tax rate in the world. Many are talking about decreasing our burdensome taxation of U S corporations.

    Now the positive set-up ---

    And in my view the more likely scenario based on history. The profit share from abroad will continue to grow, as it has for the last 30 years, and that US corporations will continue to gain global market share. Or, at least, we can infer that they will hold their own. They may gain by acquisitions, as we just saw with Monsanto. Or they may gain by market penetration, as we just saw with Apple in China & elsewhere around the globe.

    How they gain is not the important issue from the perspective of the stock/GDP ratio. As long as they gain, this measure of stock market value remains a critical macro indicator. If these assumptions are close to being right, the adjusted trend for the stock/GDP ratio would actually be below the current level rather than above it.

    Adjusted for the profit share change, the stock market is fairly valued, not richly priced. And IF the foreign-sourced earnings trend continues upward, the S&P 500 Index could easily go higher than it already has.

    And maybe THAT is what the market is also seeing, that many can't comprehend as they stand and watch the S & P go higher. All the while scratching their heads over the recent economic news here in the U.S., which has been tepid at best.

    Please take a look at the presentation I rendered just last week on the recent "positives " from the Eurozone.

    Allow me to throw out some additional thoughts with comparisons to historical norms.

    Now lets take a look at the environment as it exists today and compare it to "history" to help determine the markets valuation.

    Since 1960, Treasury yields have ranged from 15.7% in 1981 to 1.4% in 2012, with an average of about 6.5%. Benchmark 10-year Treasury yields are now currently at 2.20%, which is some 65% below normal. When you plug these metrics into the "Fed model," the S&P 500 is 59% undervalued relative to Treasury bonds, using trailing P/E's.

    Same story with inflation. Since 1960, the core Personal Consumption Expenditure (PCE) index-the Fed's preferred measure of inflation-has ranged from 10.2% in 1975 to 0.9% in 2010 on a year-over-year basis, for an average of 3.3%.

    Core PCE is currently running at 1.3% through March 2015, 60% below normal. Using the so-called "Rule of 20" methodology, below-trend core inflation at current levels would translate into a forward P/E of about 18.7 times, which suggests that stocks are about 8 and 12% undervalued, respectively, on estimated 2015 and 2016 EPS.

    In summary, over the past 55 years, the average trailing P/E for the S&P 500 is 16.5 times, with average benchmark 10-year Treasuries yielding 6.5% and average core PCE inflation at 3.3%.

    But with interest rates and inflation now well below normal at 2.20% and 1.3%, respectively, I am comfortable targeting above-average P/E's in the upper teens on forward earnings. So far the market is agreeing with that assessment. No, this it isn't wild euphoria that we are witnessing.

    Stocks are no longer as dirt cheap as they were at the bottom of the Great Recession with an 11 P/E. And they shouldn't be after the run we have just witnessed.

    BUT, given the relatively benign levels of both interest rates and inflation, particularly when compared with the return potential of other asset classes, such as cash and Treasuries, equities offer moderately attractive valuation prospects over the next 12 months or so even at S & P 2120.

    I have been and continue to position myself using what I feel are the tools which reflect the present environment we are in.

    All the while dismissing the theories and tools that have not worked and are ignoring key elements of what is happening in the global world today out of the equation.

    Best of Luck to all !!

    May 20 7:00 PM | Link | 2 Comments
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