4/17/14 9:00 PM
We wish all of our readers a happy Easter. Our next comment will appear on Thursday
The Collapse Of Momentum Stocks Is An Ominous Change
4/10/14 9:30 PM
Nasdaq’s recent weakness signifies an important change in
market leadership that seldom happens without a strong reversal of overall
market direction as the market seeks new leaders. Nasdaq has now declined 7.3% since its peak
on March 6th while the S&P 500 is off 3.4% since its high on
April 4th. Moreover, the key
momentum stocks responsible for most of the previous strength in Nasdaq are
down much more. Since their respective
peaks Three D Systems is down 51%; FireEye 49%; Splunk 45%; Yelp 37%; Tableau
software 35%; Pandora 35%; and Workday 35%.
Others such as Tesla, Netflix, Facebook, Biogen and Gilead are also off
significantly. All of these stocks
either have no earnings or are selling at extremely high price/earnings
multiples. This is reminiscent of March
2000 when the dot-com bubble started to burst amid widespread investor denial
that the bull market could come to an end.
The probable change in leadership is also accompanied by
other indications that the long cyclical bull market may have ended. The number of new daily highs in the market
has diminished on each successive rally.
Margin debt is at record highs, both on an absolute basis and relative
to GDP. According to the Investor’s
Intelligence Survey, bearish sentiment is at the lowest level since 1987. Adding to the malaise, this is happening at a
time when the Fed has begun to pull back from its Quantitative Easing policy
that has boosted stocks in the last few years although the economy is still
staggering along at a tepid pace of growth.
Yesterday (Wednesday) the market overreacted on the
upside to the release of the Fed minutes of the March meeting on the grounds
that the FOMC appeared more dovish than originally thought. The ill-conceived
rally failed to hold up and for good reason. The Fed had already issued an explanatory
statement after the meeting followed by a Janet Yellen press conference. Nothing in the minutes changes the original
statement or comments at the press conference.
The statement indicated that interest rates would be kept low for some
time after QE ended. When Yellen was
pressed to state how long that might be she offhandedly said that it could be
six months, but was subject to the incoming data as are all Fed decisions.
To be sure, there was some question about the so-called
“dots” release, based on a survey of the Fed governors that indicated a very
slight rise in the fed funds rate one-to-three years out. The minutes show the FOMC discussing how to
explain this and avoid confusion, and that it did not mean a change in the
Fed’s policy. Furthermore, at her press
conference Yellen explained that the “dot” projections changed slightly from
time to time without necessarily indicating a change.
In sum, we think there has been a distinct change in
market leadership at a time when the Fed is tapering its QE program and
economic growth is inadequate. In our view this is part of a topping process
that is likely to result in a severe market decline.
The Stock Market's Shaky Foundation
4/03/14 7:00 PM
The current level of the stock market is based on a shaky
foundation, dependent on a Fed that cannot get the economy moving and on a
business model based on not hiring labor or replacing equipment in order to
keep profit margins at an all-time peak.
This is not a sustainable growth model that justifies current market
valuations that are far above historical norms.
The economic recovery that is now five years old has
never accelerated from its ongoing tepid growth rate. Consumers, burdened by
high levels of debt and meager gains in income, are unwilling or unable to go
into further debt and have already run their savings down to historically low
rates. Real median household income
excluding capital gains and benefits, but including transfer payments, has declined
4.4% since the recession bottomed in March 2009. With consumer spending accounting for 68% of
GDP, the outlook for accelerated economic growth is bleak.
Businesses, too, have been holding a lid on
spending. According to S&P Capital
IQ, capital spending by the S&P 1500 has increased only 0.8% annually over
the last five years. Core new orders for
equipment in recent months point to continued tepid growth in capital spending
in the period ahead.
Corporations have also been reluctant to hire new employees. In the last three years the monthly
year-over-year increase in payroll employment has fluctuated between 1.59% and
1.88% and has shown no signs of a breakout to higher levels. In prior post-war economic recoveries, it was
typical to see increases of 3%-to-5% for months on end. Now, even a huge weather-related catch-up
would not lift us out of the current inadequate zone.
Keeping costs low by maintaining a lid on labor and
capital has enabled corporate earnings to soar over the last five years. In addition, corporations have used their
cash to pay more dividends and buy back stock, further helping earnings to
rise. As a result, corporate earnings
have soared to an all-time high of 11.1% of GDP, compared to 4.6% in the 3rd
quarter of 2008 and an average of about 5.4% in the 1990s. The long-term average was about 6% in the 45
years from 1955 to 2000. A reversal to
the mean is the most likely outcome.
In our view, the current trend is a house of cards. Neither consumers nor corporations are spending
enough to generate the amount of income necessary to keep the economy moving
forward at a robust pace. Traditionally,
the nation’s economy grew by building new plant, buying more equipment,
developing new products and keeping the infrastructure up to date. It seems to us that little of this is
happening now, and that the current level of earnings and profit margins are
In light of these conditions, it’s ironic that investors
would cheer Janet Yellin’s recent speech.
What the market saw was continued stimulus by the Fed. On the contrary, what we saw were the reasons
for the stimulus. Yellin stated “Since
late 2008, the Fed has taken EXTRAORIDNARY STEPS (caps are ours) to revive the
economy….I think this EXTRAORDINARY COMMITMENT is still needed and will be for
some time, and I believe that view is widely shared by my fellow policymakers
at the Fed.” To us, that is hardly a
reason for optimism. We continue to
believe that current high stock market valuations are irrational and that the
market is as close to a turning point as it was in early 2000 and late 2007.
Market Facing An Array Of Bearish Indicators
3/27/14 10:00 PM
The stock market is showing signs of topping out after
its lengthy 5-year run. This is our
takeaway from examining a wide array of factors such as technical condition,
Fed policy, the economy, earnings, valuation and China.
TECHNICAL—The S&P 500 hit an intraday peak of 1883 on
March 7th, and has failed to break higher after numerous
attempts. Trading volume has
consistently been higher on days when the market was down than when it has been
up, indicating a lack of enthusiasm on the buy side and a greater interest in
selling. Recently, stocks have typically
rallied early in the day only to give it all back and more by day’s end.
Momentum stocks featuring sky-high price/earnings ratios or no earnings at all
have been clobbered of late, indicating an increasing aversion to risk. In
recent weeks we have witnessed substantial declines in FireEye (35%), Twitter
(38%), Tesla (27%), Yelp (23%), Workaday (22%) and Netflix (21%). Yesterday (Wednesday) the IPO of highly-
anticipated King Digital Entertainment headed straight down after opening.
Daily new stock highs have diminished rapidly in the last
few months. New highs were running at
about 600 a day in November and only about 200 at the recent market highs. Since mid-February daily upside volume has
trended down at the same time that downside volume has been trending up. The Investor’s Intelligence survey shows
market sentiment at an historical extreme with 55% bullish and only 16%
bearish. The Nasdaq has carved out a
head and shoulders top and dropped below the neckline and its 50-day moving
THE FED AND THE ECONOMY—The Fed has started to withdraw
from Quantitative Easing and, if it stays on the current pace of withdrawal,
will be finished by November. In our
view, this is tantamount to tightening, and is happening at a time when
economic growth has not yet broken free of the constraints emanating from the
aftermath of the credit crisis. GDP was
up only 1.9% in 2013, down from 2.6% a year earlier. Since the recovery began, GDP growth has
averaged a paltry 2% and has not broken out from that range. Although the last half of the year seemed
stronger than the first, most of the growth was attributable to consumer
spending and inventory accumulation. Now the inventories have to be worked off,
while consumer spending depended heavily on a reduced savings rate rather than
income, and is, therefore unsustainable.
Real disposable income increased only 0.8% annualized in the 4th
quarter and was about flat with a year earlier.
In the beginning of the New Year, income, a necessary ingredient for sustainable
consumer spending, is still not picking up.
Furthermore, new orders for core capital goods, a
predictor of future capital spending, have been flat for the last 10 months. Housing, too, remains on the tepid side, with
today’s report showing pending home sales down for the 8th straight
EARNINGS AND VALUATION--At current levels the market is
substantially overvalued by historical precedent. With the S&P 500 closing today at 1849,
the P/E multiple on our calculation of cyclically-smoothed trailing reported earnings
is about 21, far above the long-term historical average of 15, and even further
above typical bear market lows of 7-to-10.
We note that our smoothed estimate is relatively conservative compared
to Robert Shiller’s highly-regarded CAPE multiple of 25.
CHINA—China is facing a slowdown in growth and a
potential credit crisis at the same time.
This puts them in the predicament of possibly having to loosen credit
when prudence would ordinarily call for reining it in. These shorter-term problems also make it more
difficult to follow its desired longer-term policy of increasing the proportion
of domestic consumer spending in the economy.
In addition the accompanying cutback in imports imperils a number of the
world’s emerging economies, thus creating serious headwinds for global growth.
(Please see our comment of March 13th for more on this).
All in all, we think that the odds of a major market
decline are high, and that the upside potential is limited.
The Fed's Futile Quest For Transparency
3/20/14 10:00 PM
In our view the market frenzy over the FOMC statement and
Janet Yellen’s press conference remarks was much ado about very little, and
resulted from the market’s quest for Fed transparency that is impossible to
On the surface, the FOMC statement seemed quite dovish,
stating that it would be appropriate to maintain the target range for the fed
funds rate for a “considerable period of time” after the end of Quantitative
Easing (QE), even after employment and inflation approached the Fed’s
goals. Taken alone, there was nothing
in the statement to justify the market’s harsh reaction. If anything, it would seem as if policy was
even easier than it was prior to the meeting.
There were, however, two factors that made investors take
notice. First, the so-called “dots” that
indicate the views of all the Fed Governors as to where the fed funds rate is
likely to be at some future period indicated a slight rise in projections. Specifically, the forecast showed a funds
rate of 1.13% for year-end 2015 and 2.42% for year-end 2016, compared to their
previous forecast of 1.06% and 2.18%.
Although this was an increase of the projection by a mere .07% for a
point almost two years away and 0.24% for a point three years out, the change
loomed large in the eyes of investors.
Second, in answering a question by a reporter as to what
was meant by “a considerable period of time”, Yellen said, almost casually,
that it was hard to define, “but probably means something on the order of
around six months or that type of thing, but what the statement is saying is
that it depends on what conditions are like.”
The answer, seemingly given reluctantly in the most off-hand manner, was
immediately pounced upon by the market as virtually the only significant item
to come out of the meeting, although Yellen tried to emphasize that, in the end
it really depended on the data.
The problem is that in analyzing the Fed’s statements,
projections, press conferences and speeches, investors are desperately seeking
a kind of transparency that is impossible to achieve. Neither the Fed nor anyone else can possibly
know future economic conditions with anywhere near enough precision to know
exactly what they are going to do even six months out, let alone one to three
In addition, in its efforts to be transparent about
future policy moves, the Fed is reliant upon forecasts that have proved to be
highly inaccurate in the past. In
January 2011, the Fed forecast GDP growth of 3.7% for 2011, 4% for 2012 and 4%
for 2013. The actual respective results
were 1.7%, 1.5% and 2%.
Rather than looking for the elusive transparency from the
Fed, we are focused on what they are doing now, and what the domestic and
global economies are telling us. The Fed
is gradually reducing QE at a rate that will end the program at the October
meeting, effective November. That, to
us, is the first step in tightening monetary policy, and it is happening at a
time when the U.S. economy is still stuck in its 2% growth rut, as it was
before the weather became the major factor to blame. In addition, as we discussed last week, the
Chinese economy is becoming a heavy burden on all of the economies dependent on
their exports to China. The stock market
has come a long way in the last five years and is now priced close to perfection
at a time when global economic growth is under pressure and geopolitical
problems proliferate. We continue to
believe that the risks, at this point are exceedingly high.
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