Bull Market Top Checklist

the Curmudgeon


Fiendbear recently emailed the Curmudgeon to inquire if the stock market bubble had burst, noting that most of the price gains were coming from NASDAQ darlings/high flyers.  Indeed, the NASDAQ and NASDAQ 100 made new all-time highs last week. The Russell 2000 small cap index is doing especially well too. We examine if the bull market has ended by citing the research of two leading investment firms.


Bull Market Top Checklist:


Let’s first look at the “Bull Market Top Checklist” provided by Strategas, a New York-based stock market research firm.


Only one of the nine checklist items Strategas cites is flashing red, but it’s a big one - weakening corporate earnings revisions. The 3rd quarter earnings reports will start in a few weeks so we’ll see if earnings are as bad as forecast. 


The September 26th Wall Street Journal (WSJ) front page article tells it all: Profit Slump for S&P 500 Heads for a Sixth Straight Quarter (on line subscription required). Analysts have been cutting estimates for U.S. earnings, after earlier projecting a return to growth during the third quarter.  Here’s an excerpt from the article:


Companies in the S&P 500 are now expected to report earnings declines for the sixth consecutive quarter in the coming weeks, according to analysts polled by FactSet. That slump would be the longest since FactSet began tracking the data in 2008.


As recently as three months ago, analysts estimated U.S. corporate earnings growth would return to positive territory by the third quarter. As of Friday, September 23rd FactSet was forecasting a 2.3% contraction from the year-earlier period.


In addition, FactSet reports that corporate earnings guidance continues to deteriorate with twice as many companies providing negative earnings growth guidance than positive guidance:


“For Q3 2016, 79 S&P 500 companies have issued negative EPS guidance and 35 S&P 500 companies have issued positive EPS guidance.”


-->The prolonged profits contraction has raised questions about how far stocks can rise without corresponding strengthening in corporate earnings.


Assessment of Bull Market Top checklist items:


1.     Blow off top - NO panic buying

2.     Heavy inflows into equity mutual funds – NO

3.     Big pick up in M&A activity – NO

4.     IPO activity strong – NO

5.    Erosion in number of stocks making new highs - NO

6.    Rising real interest rates – NO

7.    Credit Spreads rising (“5 year break-even expectations have deteriorated from a year ago as the outlook on growth has come in,” Strategas said.

8.    Shift towards defensive leadership – NO (but we say YES)

9.    Weakening upwards earnings revisions – YES (FactSet would agree)


For sure, equity mutual fund OUTFLOWS (net redemptions) combined with tepid IPO and M&A activity have not hit levels that suggest “irrational exuberance.”


Market “internals” remain supportive, especially market breadth and momentum. There is little sign of an erosion of stocks making new highs. 


The firm says there has not been a significant shift towards defensive sectors becoming the market leaders, but some may beg to differ.  Defensive market sectors like utilities, telecoms and consumer staples have done especially well this year – much better than ANY broad US stock market average.


Perhaps, the most important factor to note is that unlike the last two major stock market tops in 2000 and 2007, there is scant evidence of speculative excess.


“Retail participation in the market rally continues to be conspicuous by its absence,” Strategas notes.  “Again it appears that financial repression is stymieing our efforts, as investors, to understand the current business cycle and the nature of the financial markets. Only real and persistent signs of inflation may change that.”


Leuthold Weeden Capital Management (LWCM) Remains Bullish:


LWCM’s Chief Investment Officer, Doug Ramsey, today presented the firms market outlook for the 4th quarter on a conference call (financial professionals only).  Doug follows the firm’s quantitative based Major Trend Index, which provides the cold verdict of the market, rather than what the market should be doing.   Those indicators were solidly bearish last summer and earlier in 2016, but turned bullish in May of this year.


The firm’s Very Long Term (VLT) momentum model triggered a buy signal on the S&P 500 in May (first low risk buy signal since May 2009) and a VLT buy on the Russell 2000 at the end of this August.  The last false VLT signal was December 31, 2001 where the S&P 500 initially rose 2.1% after the buy signal was generated, but then rolled over and fell -32.3% from the buy level to market low.


As of 3:20pm Sept 27th, LWCMs Major Trend Index (MTI) was down 0.04 from last week to 1.25 (any reading above 1.00 would be considered bullish).  The individual MTI components are shown in the table below:




Table Courtesy of Leuthold Weeden Capital Management


LWCM MTI report excerpt:


The breadth and trend-following work remain the strongest elements within the Momentum/Breadth/Divergence category (and across the entire MTI, for that matter). All five of the daily iterations of the advance/decline work we track reached new bull market highs last Thursday, and the cycle high in the weekly breadth work was just three weeks ago. Historically, it’s almost invariably required at least a few months for such broad strength to dissipate before the final, narrower bull market high is recorded. We’re cognizant that the proliferation of ETFs, the adoption of decimalization by the NYSE early last decade, and the elimination of the uptick rule in 2007 have all had some likely impact on the daily breadth figures, but strength in other measures—such as new 52-week highs, equal-weighted market indexes, etc.—make it very difficult to argue that market participation has begun to narrow.


Overall, the weight of the stock market evidence continues to tilt bullish and our tactical portfolios remain fairly aggressive positioned with net equity exposure of 63%.”


However, there’s one caveat in LTCM quant work which we’ve been calling attention to for months if not years! 


The Intrinsic Value work is near a negative extreme for the current bull market with a net reading of –460. Last week’s five-point loss was triggered by a move in the MSCI World Index trailing P/E ratio into its eighth historical decile. Its weekly closing value of 21.4x compares to a reading of 18.0x at the index peak in July 2014.




The bull market seems to be intact, despite a slew of negatives: extraordinary high valuations, declining earnings growth, a geriatric bull market that’s the second longest in history, stagnant GDP, slumping productivity, uncertain fiscal policy (no matter which candidate is elected President), massive debt build-up and a rising budget deficit, etc.


Despite all of the above, the beat goes on.  However, we continue to believe that bullish investors are playing a game of musical chairs.  They are dancing to the music now, but when it stops it’ll be very hard to find a chair.  In other words, liquidity on the sell side will vanish, bid- ask spreads will widen precipitously, and the market may even shut down -with or without “circuit breakers.”

Good luck and till next time...

The Curmudgeon


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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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