Stocks Are Not Cheap: Market More Likely To Go Down Than Up

Includes: DIA, QQQ, SPY
by: Turtle Management

Whenever the market has what’s known as a “correction” (a 10%+ move down off of a recent high) we start to hear that stocks are cheap. Sometimes this may be the case, but in this instance these people either have no idea what is going on in Europe, with global growth, where profit margins currently stand, future earnings outlook, unemployment, layoffs, housing starts, housing prices, jobless claims, etc. or they are just completely incapable of seeing the bigger picture. They get excited at the opportunity to get something right when everyone else is wrong and the notion that they are smart by going against the crowd, proclaiming that “stocks are cheap, buy into the fear!”

Don’t be one of those people, as it will cost you. The market has a much better chance of going down than up in the coming months. The fear is here for a reason and stocks have been sold off for a reason. Let’s not get ahead of ourselves here and instead go over some numbers…

Growth in terms of GDP has fallen all across Europe, the U.S., and Japan to name a few. Economic theory tells us that corporate earnings can only grow as fast as a country’s GDP on the aggregate. Earnings growth drives stock prices higher and over the long haul that earnings growth is all that matters to the market. Growth can come in numerous ways, but the most common and prevalent are expanding margins or a boost in sales driven by more quantity sold or a higher overall selling price.

Currently, corporate profit margins are at a high point, and since margins cannot expand indefinitely (your net income cannot be greater than your revenue), what goes up must come down. In addition, wages in this country have been stagnant over the past few years, consumer confidence has fallen recently, and unemployment is not only understated due to the way it is calculated, but also it is on the rise.

This perfect storm of events leaves corporations without a consumer base to grow their earnings with. Consumption in this country as a percent of GDP is approximately 70%. If people do not spend, earnings do not grow. Yes many American corporations sell their product all over the world. Unfortunately, anyone arguing that point just killed their own argument. The global economy is just that, global, and if Europe and the U.S. falter, so will the rest of the world.

The biggest concern regarding the global economy (Europe aside and that is a huge issue to toss aside) is in relation to job growth. Bloomberg's website states in regards to nonfarm payrolls,

During the mature phase of an economic expansion, monthly payrolls gains of 150,000 or so are considered relatively healthy. In the early stages of recovery though, gains are expected to surpass 250,000 per month.

Currently the U.S. clocks in at 117,000 for the month of July and that number is projected to drop to 67,000 for August. The weekly jobless claims report has been steady lately at around 400,000, but should be ignored due to “layoff lag.” USPS will be laying off a few hundred thousand employees over the next year or so. HSBC is cutting 30,000 jobs, Borders thousands, Costco, Credit Suisse, Barclay’s, Goldman, and on and on. I don’t even want to get into the cuts you will continue to see in defense and other government jobs as we are forced to close our $1.2T annual deficit in this country. The ISM Manufacturing Index is expected to read 48.5 compared to 50.9 for July. A reading below 50 indicates that the manufacturing sector is contracting. This number has been falling steadily from approximately a reading of 60 at the start of the year. Oh I almost forgot; 44 million people rely on food stamps in this country.

The job situation looks bleak at the moment and appears to be worsening. Since the government housing credits expired, housing lost its false bottom and has started to give way again. Housing prices are down 5.9% as of Q2 2011 compared to Q2 2010. Don’t expect them to go up any time soon. There is a pent up supply of foreclosure backlogs just dying to come onto the market as banks have been forced to slow the rate at which they foreclose on people due to investigations into their robo-signing shenanigans.

Currently there are 2.2 million loans in foreclosure can still be saved, but many are too far gone it appears. According to Lender Processing Services some 37% of the 2.2 million have not made a payment in more than two years, while another 34% have not made a payment in 12 to 23 months. The housing market is a direct indicator of where the economy is heading as many Americans have a large portion of their net worth tied up in the real estate market.

We are in a pickle in terms of finding a realistic solution. If we cut spending we lose more jobs, growth stalls or goes negative, and the market reacts poorly (severe cuts in spending would lead to a recession if not a depression, this is not debatable so don’t waste your breath). If we print money the market may rally short term, but we can’t borrow to fund a $1.2T deficit for an infinite amount of time. Our debt is getting out of control and has been dangerously high for some time now. As a result, spending will have to be cut eventually.

Regardless of what we do in the U.S., Europe’s absurd debt situation coupled with balanced budgets and austerity will keep their growth low. There is too much that can go wrong here and the current economic numbers do not look good. Stocks are not cheap. Don’t be stupid or blinded by greed.

Bottom Line: You cannot spend more than you make forever. We may not be in a recession officially with 2 quarters of negative GDP growth, but don’t try and tell me that we are in a recovery either with unemployment around 10%. Stocks are overvalued because future earnings are being overvalued and the smart money sees that. Discount future earnings by the risk Europe blows up and I would stay away until you see the S&P the 900 to 1,000 level. Be patient and wait for the European crisis to play out because it will affect the United States. The writing is on the wall. Ignore the fickle market, look at the numbers, and make the call yourself.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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