Recent price action
The equity market hit a new all-time high, as we suggested was likely in our last weekend update. The rest of the week saw a pullback.
Anecdotal and other sentiment indications
So, as I am known to do, I will peruse articles on the web to find some interesting tidbits. And, I found one in one of Lance Robert’s recent posts.
Within this article, he cited a Doug Kass note, which stated:
“Despite many who are suggesting this has been a 'rational rise' due to strong earnings growth, that is simply not the case as shown below . . . Since 2014, the stock market has risen (capital appreciation only) by 35% while reported earnings growth has risen by a whopping 2%. A 2% growth in earnings over the last 3-years hardly justifies a 33% premium over earnings.
Of course, even reported earnings is somewhat misleading due to the heavy use of share repurchases to artificially inflate reported earnings on a per share basis. However, corporate profits after tax give us a better idea of what profits actually were since that is the amount left over after those taxes were paid.
"Again we see the same picture of a 32% premium over a 3% cumulative growth in corporate profits after tax. There is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.
We can also use the data above to construct a valuation measure of price divided by corporate profits after tax. As with all valuation measures we have discussed as of late, and forward return expectations from such levels, the P/CPATAX ratio just hit the second highest level in history."
So, what is Lance’s conclusion from the Kass note? “The reality, of course, is that investors are simply chasing asset prices higher as exuberance overtakes logic.”
And, all of this leaves me scratching my head.
First, Kass almost came to a logical conclusion when he noted that “[t]here is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.”
But, he missed the boat when he added that last word “currently.” He would have been 100% accurate if he had simply noted his conclusion without that last word. If earnings are only lining up with market direction part of the time, then it is clear that earnings are only a coincidental factor during those times rather than the driving factor.
You see, if something does not drive the market all the time, how can you assume it is really a causative factor rather than a coincidental factor during the minority of the time it is in alignment with a market move? Even if it aligns 60% of the time, it is still a coincidental factor rather than a causative factor. To state otherwise is simply not accurate. I mean, either the steering wheel directs the car all the time or it does not.
Now, let’s deal with Lance’s conclusion. Lance’s conclusion presupposes that “logic” is what normally drives the market. So, if exuberance is taking over logic, clearly he views logic as the primary and predominant force driving the market the majority of the time. Now, let me ask you this: when was the last time you sought out the services of a logician to determine the market’s next move?
And, I am quite sure I know your answer to the question I just posed. Now, do you know why you don’t seek out the services of a logician to determine the market’s next move? Yup. You guessed it. Because logicians would never be able to provide you with consistent correct responses because markets are not driven by logic. Rather, the market is driven by investor sentiment ALL the time (i.e. emotion), as compared to the erroneous belief that it is being driven by some coincidental factor, such as earnings, some of the time. But, I do have to give some credit to Doug and Lance for at least recognizing that truth about the market.
So, I wanted to share this example of how pervasively wrong Wall Street or analyst thinking really is. Moreover, this is the type of wrong thinking that is continually propagated throughout what is purported to be “analytical” writing.
I am quite certain you have read dozens, if not hundreds, of articles outlining for you what supposedly “matters” to the market, such as earnings. Yet, the market does not seem believe any of it really matters. If it did, do you think Amazon (NASDAQ:AMZN) would see the stock price we see today?
I sincerely hope that my articles at least open your mind to see through how most of the market thinks, and why it is often the wrong way to look at markets, despite it sounding so “logical.”
Price pattern sentiment indications and upcoming expectations
There comes a point in time when we have a completed pattern that we have to become much more cautious of upside during a bull market. But, at the same time, we have to respect the fact that bull markets love to extend beyond our standard targeting.
At this time, the SPX has now exceeded the target we set back in 2015 by approximately 2%. Yet, it is still possible it can extend a bit more. And, the main reason is that the Nasdaq pattern still does not look complete. In fact, it still looks like it needs one more rally to complete its structure. And, for this reason, I am still looking a bit higher into the end of the year, especially in the NQ, before the larger degree pullback I want to see in the equity market takes hold.
But, even though I am still on alert for a larger degree pullback in the market, please remember that the larger picture suggests that the SPX will likely see levels exceeding the 3000 region in the coming years before a major bear market takes hold. In fact, depending upon how long the impending pullback I expect in the market takes us, I think we can even strike or exceed the 2800SPX region in late 2018.
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