How Does the Bull Market Look Now?

By the Curmudgeon with Victor Sperandeo    



Is the bull market over?  Has the tech stock bubble burst?  What's next for the market?  These are questions many people are asking in the wake of last week's volatility and sharp declines on Thursday and Friday, which followed a big up move on Wednesday. While we don't have the answers (we don't think anyone does), Victor and I would like to share our thoughts on the five+ year bull market in U.S. equities and the outlook going forward, especially for tech stocks.

A Healthy or Artificial Bull Market?


We strongly believe that this has not been a bull market based on solid economic fundamentals, as we've pointed out in so many posts related to the "Great Disconnect" between the real economy and the equity market.  Instead, this bull run has been fueled, aided and abetted by Federal Reserve monetary policies (ZIRP and QE), record high margin debt and corporate share buybacks.  We'll focus on the latter two in this article, as past posts extensively covered the Fed and the markets.


1.  Margin Debt:

The chart below shows the tight correlation between end of month NYSE margin debt and the S&P 500.  Note that NYSE margin debt now is substantially above the previous peak in July 2007- even though share volume is a fraction of what it was then.  That implies that today's stock market is much more heavily leveraged than any time in decades.


Chart courtesy of


If one were to include NASDAQ margin debt, it would show even more leverage has been used to buy stock.  As we've pointed out in a Curmudgeon post almost one year ago, Margin Debit is a Double-Edged Sword. It’s important to note that the topping of margin debt in March 2000 and July 2007 preceded a significant drop in the S&P by several months (the caveat is that Margin Debt reported data is always a month old).


2.  Share Buybacks:

What effect have corporate share buybacks had on stock prices and earning per share? They boosted demand while contracting the supply of stock and made earnings per share higher than they'd otherwise be.


In his WSJ Ahead of the Tape column on April 7th (on line subscription required), Spencer Jakab wrote:


"During the reporting season that just ended, earnings growth slowed to a crawl and likely would have been negative without buybacks.  The bang for the buyback buck is diminishing, though, requiring more cash to remain effective. During the 12 months through January, S&P 500 companies spent a whopping $478 billion to repurchase 3.1% of shares outstanding.  A year earlier, they spent about $90 billion less for the same percentage reduction. Given today's higher values, companies will have to spend tens of billions more. If buybacks slow, so will earnings growth, all else being equal."


Jakab notes that during the previous bull market (which ended in October 2007), buybacks peaked in the same quarter the stock market did. Less than two years later, during the quarter in which stock prices bottomed, companies spent 83% less on buybacks. That is despite the fact they would have gotten far more earnings-boosting effect at those low prices for each dollar spent.  Please see chart below:



Decline in Tech Stocks:

We think the rout in tech stocks is just getting started.  This week's Barron's cover "The Tech Stock Bust Should be no Surprise" calls attention to what we wrote about this past January: Tech Bubble 2.0 Will End Badly Just Like the First Tech Bubble. And that was BEFORE Facebook's $19B acquisition of WhatsApp (mobile messaging) and $2B purchase of Oculus VR (virtual reality game headwear).

What's happened since then:  In the past few weeks, an abrupt change in sentiment has caused falls of 20%-45% in former tech darlings like Netflix, Facebook, Twitter and LinkedIn. The tech-heavy Nasdaq composite index closed at nearly 4,358 early last month, its highest level since the 2000 peak, and has shed nearly 360 points - or 8% - since then.


Other Voices on the Tech Stock Decline:

This weekend's Financial Times Lex column noted: "Without a clear catalyst for the sell-off, one implicit marker should be Facebook’s second recent billion-dollar acquisition, Oculus Rift. Founder Mark Zuckerberg threw down $2bn for the virtual reality headgear (goggles) concept on March 25th. Facebook shares since that day are down over 10%."


Now that government-backed bond purchases (Fed's QE) are tapering off, people are starting to realize "the only thing holding this balloon up is the Fed blowing air in it," said Fred Hickey, editor of The High-Tech Strategist newsletter. "It's the most insane pricing I have seen since 2000," Hickey said regarding technology stock prices.  

“March was a wake-up call from the market to many long-short funds that had been relying on certain stocks and sectors for the past couple of months,” says Matthew Elstrop, an analyst at Liongate Capital Management, a fund of hedge funds with $7bn of assets invested in the sector. “A lot of crowded trades, such as high growth tech stocks, just went into reversal.”


John Paulson, the hedge fund manager who built his reputation betting heavily against the U.S. housing bubble before the financial crisis, saw his $2.8bn Advantage Plus fund (which is focused on so-called event driven or momentum trading), drop by 7.4% in March, according to the Financial Times.


Research from Morgan Stanley’s prime brokerage suggests that few hedge funds have started to offload their so-called “new tech” shareholdings yet, although that may change if these companies continue to fall in value.  “So far we haven’t seen big changes in hedge fund positions,” says Mr. Ince. "In fact, they may actually like some of the technology shares even more now they are cheaper.”  


Curmudgeon's Opinion: Such "buy the dips" mentality implies to us that the tech stock decline is not over yet.  For that to happen, we'd like to see much more pessimism and urgent selling.


The Smart Money Flow Index (SMFI):

One measure of sentiment that we've started to watch closely is Bloomberg's Smart Money Flow Index (SMFI).   It is calculated by taking the price of the Dow Jones Industrial Average at 10am (Eastern Time) on any given day, subtracting it from the previous day's close, and adding it to the next day's closing price.  The first 30 minutes represent "emotional buying," driven by greed and fear of the crowd; veteran traders (i.e. the smart money) typically wait until the end of the day to place their orders.


As the chart below shows the DJI and SMFI rallied in unison to make dual highs in May 2013.  While the Dow continued to push higher, the SMFI made lower highs and has collapsed since late Feb 2014.  It is now at its lowest close since Nov 27, 2012. It's the greatest gap since 2007.


Chart courtesy of Bloomberg


Dennis Slothower of Alpine Capital wrote in an email to the Curmudgeon, "Smart money waits until the end of the trading day and they very often test the market before then by shorting heavily just to see how the market reacts. Then they move in the big way. These heavy hitters also have the best possible information available to them and they do have the edge on all the other market participants. To replicate this index, just start at any given day, subtract the price of the Dow at 10AM from the previous day's close and add today's closing price. Whenever the Dow makes a high which is not confirmed by the SMFI there is trouble ahead."


Minyanville's Todd Harrison:  "There is no Holy Grail when investing, but there are on occasion, signals that provide the right insight at the right time. This (divergence) may be one of them."


Victor's Closing Comments:

The bull market must be taken into context of zero short term interest rates during the last six years and well into 2015, according to Fed Chairwoman Janet Yellen.  Add three QE's and other Fed schemes, such as "operation twist" (which was done twice in an attempt to lower long term interest rates) and you can understand how this bull market was nurtured and sustained. 


Yet despite this extraordinary ultra-easy monetary policy, the U.S. economy has only grown at approximately 2.2% since the "recession ended" in June 2009.  The BEA said that "Real GDP" increased 1.9% in 2013 compared with an increase of 2.8 percent in 2012. 


Editor's Note:  By comparison, the S&P 500 rose 30% in 2013 and 13% in 2012.


But has U.S. GDP growth really been as strong as reported?  We don't think so.


The U.S. government stated annual inflation rate has been 2.2% since June 2009.  If inflation is higher than that (we think it is and others do too), then real GDP would be even lower than reported.  That would make the "great disconnect" between the super strong stock market and weak economy even more glaring.


There are other factors to consider when determining the "Real GDP."  For example, the U.S. government includes about 15% of "imputations" (goods and services that are not traded in the market place) in the published GDP rate, even though sales never really occurred. "GDP Imputations" approximate the price and quantity that would be obtained for a good or service if it was traded in the market place.  These "GDP Imputations" are government manipulations of numbers on the highest order, in my humble opinion.


Together with all the manipulations of interest rates, bonds, the dollar, gold and other items (stock indices?) the government's flawed GDP numbers really make all fundamental analysis and assumptions worthless!

The crucial issue for today's stock market is to honestly and objectively analyze what has happened, ask why, and attempt to determine if the market move has been based on sound economic fundamentals or something more akin to a "tulip bulb" mania?

Market timing is something else and quite difficult, especially with unexpected Fed intervention in the markets or moving to an even more dovish monetary policy (like a stop in tapering).  The onset of a bear market in equities will truly occur when Janet Yellen can't control the events. Other than that, everything is risky and very hard to predict. Being hedged is the only prudent thought I have to recommend at this moment.


Till next time........................


The Curmudgeon

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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