Equity market warrants caution….

A couple of posts on Zerohedge.com point out overvalued metrics on US equities:

http://www.zerohedge.com/news/2015-01-12/us-stocks-most-overvalued-relative-rest-world-history

http://www.zerohedge.com/news/2015-01-10/permabull-throws-towel-stocks-are-massively-overvalued-key-multiples-are-post-war-re

The latter refers to Jim Paulsen of Wells…  I had previously put out this note, summarizing several other metrics indicating overvaluation, noted below.

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Reasons for caution

1) Technicals

  1. a) Profits as % of GDP are at record highs (at a time that wages haven’t grown in real terms).  This has been going on for some time, but it doesn’t seem reasonable to expect it to continue in the face of dollar strength and disinflationary pressures from Asia and Europe/ see below
  2. b) Margin debt is near record highs http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php
  3. c) Shiller p/e ratio is at danger level 26.4   http://www.multpl.com/shiller-pe/
  4. d) Market cap to GDP is at level only exceeded by Nasdaq bubble (one of Warren Buffet’s favorite measures)  https://research.stlouisfed.org/fred2/graph/?graph_id=164130&category_id=0

 

2) Considerations with respect to other domestic measures

a) The US yield curve flattened dramatically in 2014, and even further in the first few days of 2015.  This is a HUGE warning sign.  With a zero FF rate, the curve can’t really invert, which is a predictor of a recession, but the treasury curve is on the SAME TRAJECTORY as it was in 2004-2006, the last time the Fed was on a tightening cycle and the curve inverted.  We know what happened in late 2007.  (see my notes on chartpoint.com)

b) US commodities have been in a bear market.  Not just oil, but grains, copper, etc.  The energy sector is responsible for the a majority of job growth over the past year.  That will now go into reverse.  Here is a chart of CRB index to SPX…Divergence! CRB in white, SPX in red.

SPX CRY 2015

 

 

 

 

 

 

 

  1. c) there has been some deleveraging on the consumer side in the US.  This is a positive, but not as big as people think.  On the other hand, Corporate Debt is at a record level nominally.  In terms of debt service, corporates’ ability to service debt is high, however, credit  spreads are moving out…see below.  Company buybacks have been one of the MAIN drivers of stock strength and growing corporate debt loads.
  2. d) Junk bond spreads in the US are moving higher and are now at levels around the surge seen in mid-October.  The Fed had forced players into lower rated credits in a reach for yield, now those spreads are starting to reverse, especially given the crude oil sell off.
  3. e) inflation is edging lower.  Why is that a problem??  Not because of lower costs for consumers, but because assets no longer throw off enough income to service debts associated with them.  A negative liquidation spiral is the risk (that the central banks in the world are very aware of).

 

3) Global concerns

  1. a) EURO at risk of failing, as is well known.  There is too much bad debt/assets in Eurozone banks.  Well advertised
  2. b) Japan continues to depreciate the yen, but in a demographic nightmare the economy of Japan cannot be SAVED without massive immigration.
  3. c) This has led to the very real risk that China depreciates as a response to Japan “stealing” market share, which is HIGHLY disinflationary, as is strength in the $ in general.  Domestic US companies face pressure from cheaper imports, and US exporters’ goods become ‘priced out’ of overseas markets.
  4. d) Strength in the dollar has been a disaster for emerging market economies.  See EEM (emerging market ETF). Don’t forget that emerging markets have become a larger percentage of the global economy, and in 1998 the EM crisis threw stocks into a tailspin.

 

Conclusion, the US equity market has been the beneficiary of global capital flows due to crashing yields in Developed economies.  Company buybacks have been a big driver in retiring shares outstanding, making EPS look better.  Depressed sovereign yields make any dividend return seem valuable by comparison, a benefit to stocks.  Are those flows likely to continue through 2015, I doubt it.

 

Posted on January 12, 2015 at 8:12 am by alexmanzara · Permalink
In: Eurodollar Options

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