Category: Stock Markets

Analysis of major stock markets around the world.

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Bear market confirmed

The Dow Jones Industrial Average closed at 41,433 after marginally breaking primary support at 42,000 yesterday. This confirms a bear market in terms of Dow Theory.

Dow Jones Industrial Average

Confirmation comes after an earlier bear signal, breaching primary support on the Transportation Average below.

Dow Jones Transportation Average

The S&P 500 also signals a primary downtrend after breaching support at 5,800, strengthening the Dow bear signal.

S&P 500

The equal-weighted S&P 500 index ($IQX) was the last shoe to drop, breaking primary support at 7,000 on Tuesday.

S&P 500 Equal-Weighted Index

Further confirmation comes from the Russell 2000 Small Caps ETF (IWM), in a primary downtrend after breaking support at 214.

Russell 2000 Small Cap ETF (IWM)

The Nasdaq QQQ ETF also broke primary support at 500, warning of a bear market.

Invesco Nasdaq 100 ETF (QQQ)

Conclusion

We now have confirmation of a bear market from all the major indexes.

Bear markets typically result in a 30 to 50 percent drawdown. With stock valuations at extremes, this one is unlikely to disappoint.

Stock Market Pricing Indicator

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The Great Pumpkin | Eric Cinnamond

Great stock market analogy from Eric Cinnamond at Palm Valley Capital:

As a kid I always looked forward to Halloween. Growing up in a health-conscious “no sweets” household, Halloween was an opportunistic time to load up on my favorite chocolate bars and candy. If I played my bag of treats right, my sweet tooth could be satisfied until Christmas!

Another thing I enjoyed about Halloween was the television special, It’s the Great Pumpkin, Charlie Brown. It was and remains a classic. Released in 1966, the Peanuts special follows its cast members as they celebrate Halloween. Some of the Peanuts crew go trick-or-treating, while others attend a party. But not Linus—he does his own thing.

Instead of celebrating with his friends, Linus spends his Halloween waiting in a pumpkin patch for the Great Pumpkin. According to Linus, “On Halloween night, the Great Pumpkin rises from his pumpkin patch and flies through the air with his bag of toys to all the children.” Unfortunately, the Great Pumpkin never arrives, and Linus is ridiculed by his friends. He’s even called a blockhead!

Our belief in full market cycles, including a bull and bear market, is beginning to feel more and more like Linus’s belief in the Great Pumpkin. However, instead of pumpkins, we sit in a patch of T-bills waiting for the return of sensible equity valuations. And rather than bringing a bag of toys, we expect this cycle’s Great Pumpkin (bear market) will bring patient investors the gift of lower prices and opportunity.

From the outside looking in, believing in full market cycles, bear markets, and even recessions, probably looks foolish. To some, we might even look like blockheads! Nevertheless, we continue to believe equity valuations are very expensive, exposing investors to considerable risk. In fact, we consider this stage of the market cycle to be an asset bubble—the third stock market bubble of our careers. The first two bubbles were verified by significant losses, with the S&P 500 losing half of its value during both bear markets (2000-2002 -49% and 2007-2009 -56%).

Our latest page on stock market valuation supports his view:

Stock Market Value Indicator

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Why invest in stocks?

Some clients are understandably nervous about investing in stocks because of the volatility. Invest at the wrong time and you can experience a draw-down that takes years to recover. Many shy away, preferring the security of term deposits or the bricks and mortar of real estate investments.

The best argument for investing in stocks is two of the most enduring long-term trends in finance.

First, the secular down-trend in purchasing power of the Dollar.

Dollar Purchasing Power

Inflation has been eating away at investors’ capital for more than ninety years. Purchasing power of the Dollar declined from 794 in 1933 to 33 today — a loss of almost 96%. That means $24 today can only buy what one Dollar bought in 1933.

The second trend, by no coincidence, is the appreciation of real asset prices over the same time period.

The S&P 500 grew from 7.03 at the start of 1933 to 4546 in June 2023 — 649 times the original investment.

S&P 500 Index

Gold data is only available since 1959. In April 1933, President Franklin Roosevelt signed Executive Order 6102, forbidding “the hoarding of Gold Coin, Gold Bullion, and Gold Certificates” by US citizens. Americans were required to hand in their gold by May 1st in return for compensation at $20.67 per ounce. Since then, Gold has appreciated 94.5 times its 1933 exchange value in Dollar terms.

Spot Gold Prices

Over time, investing in real assets has protected investors’ capital from the ravages of inflation, while financial assets have for long periods failed to adequately compensate investors in real terms (after inflation). The chart below compares the yield on Moody’s Aaa corporate bonds to CPI inflation.

Moody's Aaa Corporate Bond Yield & CPI

Conclusion

Purchasing power of the Dollar depreciated by 24 times over the past ninety years due to inflation. Adjusting for inflation, the S&P 500 has grown to 27 times its original Dollar value in 1933, while Gold gained 3.9 times in real terms.

We would argue that the consumer price index understates inflation. Gold does not grow in value — it is constant in real terms.

If we take Gold as our benchmark of real value, then the S&P 500 has grown 6.8 times in real terms — a far more believable performance.

Stocks are a great hedge against inflation provided the investor can tolerate volatility in their portfolio. How to manage volatility will be the subject of discussion in a further update.

Acknowledgents

 

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Have stock prices lost touch with reality?

Robert Shiller’s cyclically-adjusted PE (or CAPE) is at a similar level to the 1929 peak before the greatest crash in US history. CAPE uses a 10-year average of inflation-adjusted earnings in order to smooth out fluctuations in earnings. The current reading of 29.2 is almost double the low during the 2008 global financial crisis (GFC).

S&P 500

We use a different approach. Rather than smoothing earnings with a moving average, we use highest trailing earnings as the best indication of future earnings potential. Earnings may fall during a recession but stock prices tend to fall by less, in expectation of a recovery. Our projected value for the end of Q4 is based on highest trailing 12 months earnings at Q1 of 2022. At 20.16, the PE is higher than 1929 and 1987 peaks, which preceded major crashes, but still much lower than the Dotcom bubble.

S&P 500

Forward price-earnings ratio is more reasonable at 17.91.

S&P 500

But S&P earnings forecasts seem optimistic, with no indication of a recession in 2023.

S&P 500 Historic Earnings & Forecast Earnings

Declining real sales growth, in the first half of 2022, suggests that profit margins will come under pressure, with both earnings and multiples declining in the next 12 months.

S&P 500 Real Sales Growth

Shifting from earnings to a wider perspective, price-to-sales for the S&P 500 avoids distortion caused by fluctuating profit margins. Projected to rise to 2.30 in Q4 (based on the current S&P price and Q3 sales), prices are similarly elevated compared to the long-term average of 1.68.

S&P 500/Sales

Price to book value, estimated at 4.01 for Q4, shows a similar rise compared to a long-term average of 3.07.

S&P 500/Book Value

Warren Buffett’s favorite indicator of market pricing compares stock market capitalization to GDP, eliminating distortions from fluctuating profit margins and stock buybacks. The Q3 value of 2.0 is way above the long-term average of 1.03, suggesting that stocks are way over-priced.

US Stock Market Capitalization/GDP

Australia

Data is a lot more difficult to obtain for the ASX, but the ratio of market cap to GDP (Buffett’s indicator) is a lot more modest, at 0.96, indicating prices are close to fair value.

ASX Stock Market Capitalization/GDP

Conclusion

The chart below shows how rising US liquidity (black) fueled rising stock prices as reflected by the ratio of market cap to GDP (blue). The steep rise in the money stock (M2 excluding time deposits) after the 2008 GFC, created a scarcity of investment-grade assets, driving down interest rates and driving up stock prices.

US Stock Market Capitalization & M2/GDP

Central banks are now shrinking liquidity, in an attempt to tame inflation, and stock prices are likely to fall.

We estimate that US stocks are likely to fall between 30% and 50% if there is a recession next year. Australian stock prices are a lot closer to fair value and only likely to fall 10% to 20% in the event of a recession.

In our view a recession is almost inevitable in 2023 as the Fed cannot inject liquidity to create a soft landing — as it has done repeatedly in recent times — because of the threat of inflation.

Acknowledgements

  • The graphs of Robert Shillers CAPE, S&P 500 real sales growth, and S&P 500 price-to-book value are from multpl.com
  • Sales and earnings for the S&P 500 are from spglobal.com
  • All other US data is from FRED at stlouisfed.org
  • Market cap for the ASX is from asx.com.au while GDP is from the RBA.
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ASX double-bottom breakout

The ASX 200 completed a double-bottom reversal with breakout above 7100, suggesting another test of resistance at 7600. The signal is strengthened by subsequent retracement that respected the new support level at 7100, as well as 100-day Momentum crossover above zero.

ASX 200

Australian Bond ETFs are forming a base, signaling that expectations of long-term interest rates have plateaued.

Australian Bond ETFs

A-REITs rallied off support at 1200, penetrating the descending trendline which suggests that a base is forming. However, the move has not been confirmed by 100-day Momentum which remains well below zero.

ASX 200 REITs

Financials have made a stronger recovery, breaking above their August high, with Momentum crossing above zero. We expect a test of 7000.

ASX 200 Financials

Housing price growth is slowing as the RBA hikes interest rates.

Housing

But low unemployment keeps bank loan impairments down.

Unemployment

Net interest margins remain under pressure, however, as liquidity tightens.

Net Interest Margins

Consumer Discretionary continues to test resistance at 3000 but respect remains likely, which would warn of further consolidation.

ASX 200 Discretionary

Staples rallied off long-term support at 12000 but Momentum remains below zero. Breakout above resistance at 13000 would signal another test of 14000.

ASX 200 Staples

A higher trough on Health Care and 100-day Momentum cross to above zero are bullish signs. Breakout above 44K would signal another advance, with a target of 49K (44K + 44K – 39K).

ASX 200 Health Care

Information Technology remains weak, with 100-day Momentum deep below zero. Expect another test of 1250.

ASX 200 Information Technology

Utilities broke resistance at 8400, signaling an advance. Momentum crossover to above zero strengthens the bull signal..

ASX 200 Utilities

Industrials are headed for another test of resistance at 6700. But further ranging between 6000 and 6750 remains likely.

ASX 200 Industrials

Telecommunications are slowly edging towards resistance at 1500 but Momentum below zero indicates weakness.

ASX 200 Telecommunications

Energy remains in a long-term up-trend, testing resistance at 12000. Retracement that respects support at 11000 would strengthen the bull signal.

ASX 200 Energy

The ASX 300 Metals & Mining index broke resistance at 5650, signaling an up-trend. Retracement that respected the new support level and 100-day Momentum cross to above zero both strengthen the bull signal.

ASX 300 Metals & Mining

But weakness in major metal groups makes us wary. Declining iron ore prices are testing support at 90. Breach would signal a test of $50/tonne

Iron Ore

Base metals are similarly testing support at 150. Breach would warn of another test of 100.

DJ Industrial Metals Index

The All Ordinaries Gold Index broke through resistance at 5500, with retracement respecting the new support level to confirm the breakout. But 100-day Momentum is a long way below zero, warning buyers to be wary. Expect further tests of the new support level.

All Ordinaries Gold Index

The Australian Dollar is ranging between A$2500 and A$2700 with no clear direction at present.

Gold in Australian Dollars

Conclusion

Growth in Australia is slowing but recession is unlikely unless there is a sharp rise in unemployment — and fall in the housing market — or a global recession.

ASX 200 completed a double-bottom reversal, offering a target of 7600, but we do not believe this to be the start of a bull market. A negative yield curve in the US, warning of a recession next year, makes a bull market unlikely. Respect of resistance at 7600 would confirm that we are still in a bear market.

Our weighting for ASX sectors (ST = short-term, LT = long-term):

  • A-REITs: ST underweight, LT overweight in industrial REITs
  • Financials: overweight
  • Staples: overweight
  • Discretionary: ST underweight, LT neutral
  • Utilities: overweight
  • Industrials: neutral
  • Telecommunications: neutral
  • Health Care: overweight
  • Information Technology: underweight
  • Energy: overweight
  • Iron ore & Base Metals: ST underweight, LT neutral
  • Critical Materials: heavily overweight
  • Gold: ST neutral, LT overweight
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It’s a bear market

The S&P 500 broke primary support at 4170 to confirm a bear market. A Trend Index peak at zero warns of strong selling pressure.

S&P 500

The Nasdaq 100 similarly broke support at 13K, confirming the bear market.

Nasdaq 100

Dow Jones Industrial Average, already in a primary down-trend, confirmed the bear market with a break below 32.5K.

Dow Jones Industrial Average

The Transportation Average lags slightly, testing primary support at 14.5K. Follow-through below 14K would be the final nail in the coffin.

Dow Jones Transportation Average

A plunging Freightwaves National Truckload Index warns that we should not have long to wait.

Freightwaves Truckload Index

Conclusion

All major US stock market indices now warn of a bear market. Weak retracement, to test new resistance levels, should not be confused with a buy-the-dip opportunity.

S&P 500

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Stocks: Winter is coming

GDP grew by a solid 10.64% for the 12 months ended March ’22 but that is in nominal terms.

GDP

GDP for the quarter slowed to 1.58%, while real GDP fell to -0.36%. Not only is growth slowing but inflation is taking a bigger bite.

GDP & Real GDP

The implicit price deflator climbed to 1.94% for the quarter — almost 8.0% when annualized.

GDP Implicit Price Deflator

Growth is expected to decline further as long-term interest rates rise.

10-Year Treasury Yield & Moody's Baa Corporate Bond Yield

Conventional monetary policy would be for the Fed to hike the funds rate (gray below) above CPI (red). But, with CPI at 8.56% for the 12 months to March and FFR at 0.20%, the Fed may be tempted to try unconventional methods to ease inflationary pressures.

Fed Funds Rate & CPI

That includes shrinking its $9 trillion balance sheet (QT).

During the pandemic, the Fed purchased almost $5 trillion of securities. The resulting shortage of Treasuries and mortgage-backed securities (MBS) caused long-terms yields to fall and a migration of investors to equities in search of yield.

The Fed is expected to commence QT in May at the rate of $95 billion per month — $60 billion in Treasuries and $35 billion in MBS — after a phase-in over the first three months. Long-term Treasury yields are likely to rise even faster, accompanied by a reverse flow from equities into bonds.

S&P 500 & Fed Total Assets

S&P 500 breach of support at 4200, signaling a bear market, would anticipate this.

Conclusion

Fed rate hikes combined with QT are expected to drive long-term interest rates higher and cause an outflow from equities into bonds.

A bear market (Winter) is coming.

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A slow-motion train wreck

Facebook parent Meta’s shares fell 20% after hours as it said revenue growth will slow, partly because users were spending less time on lucrative services. (WSJ)

Meta Platforms (FB)

Facebook lost about half a million global daily users in the fourth quarter of 2021 compared to the previous quarter, according to the quarterly earnings report of Meta, its parent company. That might not seem like a major drop relative to its under 1.93 billion total daily active users, but it represents a low point for a metrics-driven company whose user base long grew at a rapid pace across its different apps. The statistic shows how Meta has struggled to stay relevant to younger users, many of whom are drawn to competing apps like TikTok. (Vox)

Facebook/Meta’s dissapointing performance is not an isolated problem. Tesla (TSLA), the darling of retail investors — trading at 22 times sales and 93 times forward earnings — is also staring into the abyss. Breaking primary support at 900 last week, TSLA quickly recovered — indicating a false break — but is again testing the 900 support level. Trend Index peaks below zero warn of selling pressure. Breach of support at 900 for a second time would confirm a primary down-trend. Initial target for a decline would be 600 — a 50 per cent fall from its recent peak of 1200.

Tesla (TSLA)

Jesse Felder shows how precarious the market situation is, with the median price-to-sales ratio at a record 3.5 times. Compare that to the Dotcom bubble, with a peak of just 2.0.

Median Price to Sales ratio

Warren Buffett’s favorite market valuation metric of market-capitalization-to-GDP is not quite as alarming, when you compare to the Dotcom peak in 2000, but nevertheless sounds a grim warning.

Market Cap/GDP

We consider MarketCap/GDP to be the most accurate long-term valuation metric available. By focusing on total stock market valuation relative to output, it avoids distortions caused by the financial trickery of stock buybacks and fluctuating profit margins caused by factors like the current supply chain issues.

Conclusion

This is like watching a slow-motion train wreck. The worst I have seen in nearly forty years in financial markets. The Fed may be able to postpone a market crash by several months but the eventual outcome is inevitable. The draw-down has the potential to be truly eye-watering, overshadowing the Dotcom Crash and Global Financial Crisis.

We are overweight Gold (including gold miners), defensive stocks, and key commodities and underweight high-multiple growth stocks.

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Robinhood results warn of bear market

Robinhood Logo

More bear market signals, this time from stock-trading app, Robinhood. A favorite among retail traders, with more than 22 million funded accounts, trading boomed during the pandemic when stuck-at-home retail traders sought to trade with funds from government stimulus payments. Now stimulus is fading and the retail trading app faces sharp declines in trading activity.

Robinhood shares tank 15% after it loses active users, forecasts weak revenue

Robinhood gave a bleak revenue forecast for the first quarter of 2022 on Thursday as its latest earnings report showed a decline in active users. The newly public brokerage anticipates first-quarter revenue of less than $340 million, down 35% compared with 2021…..Monthly active users fell to 17.3 million last quarter from 18.9 million in the third quarter. (CNBC)

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ASX signals a bear market

The ASX 200 broke support at 7200, signaling a primary down-trend. The declining Trend Index has warned of fading buying pressure for several months. Expect retracement to test the new 7200 resistance level but respect is likely and would confirm the primary down-trend.

ASX 200
The largest sector, Financials, similarly broke support at 6250 and we expect retracement to test the new resistance level.

ASX 200 Financials
The ASX 300 Metals & Mining Index encountered resistance at 6000 but remains in an up-trend. Another test of 4750 is likely.

ASX 300 Metals & Mining
The All Ordinaries Gold Index retreated this week, under the weight of a broad equities sell-off, but a rising Trend Index continues to flag buying pressure.

All Ordinaries Gold Index
Gold priced in Australian Dollars continues to trend upwards, the recent shallow trough having respected support at 2500. Target for the advance is 2800.

Gold in Australian Dollars
Conclusion

The ASX 200 breach of support at 7200 warns of a bear market; retracement that respects the new 7200 resistance level would confirm. Financials also warn of a bear market, while the Metals & Mining sector is likely to test support at 4750. The All Ordinaries Gold Index is retreating to test support at 6000 but this should present a buy opportunity as the Australian Dollar price of Gold continues in an up-trend.

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