The Silence is Deafening: U.S. Stock Market Doesn’t
Have a Care in the World?
By the Curmudgeon with Victor Sperandeo
The Big Picture:
What me worry? Not after the V shaped recovery in the U.S. stock market since October 15th, suspiciously led by the worst performing index YTD at that time- the Russell 2000. Volatility, as measured by the VIX, has dropped from 25 to 13.31 as of Friday's (Nov 14) close. And none of the negatives that market participants were worrying about during the Sept-Oct decline have gone away (the Ebola virus scare is a possible exception, but it may resurface).
The "wall of worry" list includes:
-Geopolitical risks in Ukraine/Russia, Syria & Iraq/ISIS, Iran/nukes.
-European economies headed for recession or already in one.
-Slower growth in China (the driver of commodity prices).
-Stagnation in Japan (despite the BoJ's version of QE on steroids).
-Huge disconnect: U.S. stock prices vs U.S. and global economic growth (see Yardeni chart below).
-U.S. stock market overvaluation based on numerous metrics and gauges.
-Overstated corporate profits using accounting tricks.
-An advance without a 10% correction in over 3 years.
-Overly bullish investor sentiment (more on that later).
David Stockman concurs with our analysis. He wrote in a Nov 14th blog post Take Cover Now—-They Don’t Ring a Bell At The Top:
"Bounteous wealth is seemingly to be had by the three second exercise of clicking “buy” on the SPU (basket of S&P 500 stocks). Indeed, for the past 68 months running, the stock market has blown through every mini-correction, and has been traversing a near parabolic rise (see Victor's related comments below)."
Continuing: "Needless to say, this relentless expansion of the bubble eventually kills off the bears, the skeptics, the prudent and even the militantly incredulous. Undoubtedly, that is where we are now because the global economic news has been uniformly negative since the October dip, yet the market has resumed its relentless melt-up."
Ed Yardeni, PhD created the "Global Growth Barometer (GGB)" a few years ago. It's an average of the CRB raw industrials spot price index and the price of a barrel of Brent crude oil. The S&P 500 was very highly correlated with this barometer from mid-2008 till the end of 2012, as can be seen in the chart below. The recent divergence exemplifies what we've called "the great disconnect."
Chart courtesy of Yardeni Research Inc.
Share Buybacks Continue to the Fuel the Market:
We have repeatedly pointed to share buybacks as a driving
force behind the markets uncorrected three year advance. Earlier this year, we wrote a post titled: How Long Will Stock Buybacks
Fuel the Bull Market?
Here's what columnist John Authers had to say about that in the Nov 15-16th Financial Times (on line subscription required):
"U.S. companies will buy $450bn of their stock this year, but when will this become too expensive?"
Authers says that one type of stock buyer looms in importance over all others. According to Goldman Sachs, US companies will buy $450bn of their own stock this year. That is 50% more than mutual funds and exchange-traded funds will buy, and will cancel out households’ ongoing liquidation of their direct equity holdings, at $430bn.
"What individuals do with their money, and how big institutions allocate their assets, both matter to share prices. But they pale into insignificance compared with corporations, Authers added.
Howard Silverblatt of Standard & Poor’s reports that S&P 500 companies bought back $155bn of their own stock during the third quarter. Over the past four quarters they have spent $560bn, the most since the crisis.
This helps explain why the stock market keeps rising. With debt still cheap, the logic of using cash to buy stock, reduce the float of shares, and hence increase earnings per share for investors, remains strong. That's largely due to global economic stagnation, which is a huge deterrent to increased capital spending or new hiring by corporations.
Corporate America differs deeply from corporate Europe in this area. Patrik Schowitz, a global strategist at JPMorgan Asset Management, says that since 2002, share floats have shrunk by 0.1% (diminished net supply of stock) per year in the U.S., while rising by 0.6% (increased net supply of stock) per year in Europe.
The outperformance of companies who do the most stock repurchases is striking. Since the bear market low of March 2009 the Powershares Buyback Achievers ETF has returned 273%, against 203% for the S&P 500. Since its 2011 inception, the TrimTabs Float Shrink ETF has done even better, and beaten the S&P by more than 20 percentage points.
The above numbers are unmistakable evidence that companies which deliberately shrink their float of stock are leading the market.
Mr. Schowitz thinks that US companies are returning between 80% and 90% of their earnings to shareholders. His best prediction is buybacks will fall, but not by a huge amount, as earnings disappoint. The key question is how much will they fall and who will pick up the buying at that time?
Investor Sentiment Again at an Extreme:
Investor sentiment as measured by the weekly poll of its members by the American Association of Individual Investors (AAII) was at 52.7% bullish the past week, above the warning zone of 50% bullish. Meanwhile, the bearish percentage fell below the 20% complacency danger zone.
This week’s AAII poll showed an additional jump in investor bullishness from 52.69% to 57.93%, while bearishness remained below 20% at 19.3%.
The Investors Intelligence advisor sentiment survey shows increasing bullishness and decreasing bearish the last three weeks. The latest survey show 55.5% of advisors are bullish, while only 14.8% are bearish.
Oct 28 47.0 16.3
Nov 4 54.6 15.1
Nov 11 55.5 14.8
This is one of the very few times in history that both the AAII and Investors Intelligence surveys were each showing at least 75% bullishness, as measured by bulls / (bulls+bears). This measure weeds out the “neutral” and “correction” categories.
Since the inception of the AAII in 1987, the current readings represent just the fourth time ever in which the bullish % in both surveys was at least 75.
But heck, why worry? We've got momentum and seasonality on our side, so nothing can possibly go wrong!
I believe that the 75 degree "trend line slope" of the current U.S. stock market advance is unsustainable. Since 10/15/14 to date (11/14/14) it looks like a straight up icicle. After 5.7 years of almost uninterrupted rising stock prices, I am estimating the slope of the recent up move is truly unique.
The historical trend line slope of bull markets is typically 45 degrees. Weak bull moves like in Jimmy Carter's 1977 -1980 advance had less than a 40 degree slope. Rarely is it over 50 degrees.
A bear market rally based on short covering has this kind of action, but it only lasts for a short period of time. Certainly, after a long bull market this type of up move is at best rare. It has the similar attributes of a rocket fired into the sky and has to de-accelerate as the propulsion fuel runs out.
Also, the divergence in the advance decline line and new highs on the S&P 500 still exists, so you have more knowledge that this is indeed "dark territory."
Now at best there has to be a minor selloff, or consolidation, and at worst a major top, which would be the climax of the current bull run. In either case, this is a very unusually high risk period, in my humble opinion.
Another risk not mentioned by the CURMUDGEON above, is a possible constitutional confrontation between the President and Congress over immigration reform. This constitutional question will be decided over a long period.
The analogy of these problems goes back to the most crooked President in US history -- Richard Nixon (because he was stupid enough to get caught). In 1973, the S&P 500 was down 17.37%* mostly due to the OPEC oil embargo. In 1974, the S&P was down 29.72%*, because of the Watergate cover-up of a burglary and Congress circling the President. Such a battle between the President and Congress is not considered today by "investors," but it has historically meaningful ramifications for the stock market.
This market has fooled most people, especially the people who don't have to be long like those who run 'long only' mutual funds. Zero interest rates and several rounds of QE for six years was not 'ever' considered possible...yet it's happened and has not changed yet!
It is our goal in these posts to present risks that others don't. Indeed, that is what we try to do. Each person can evaluate the potential of these observations and concerns in light of their own circumstances. Good luck.
Till next time......
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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