Flush with new money, the S&P 500 broke resistance at 3030 this week to set a new high. Declining Money Flow, however, warns of selling pressure. Expect retracement to test the new support level at 3000. Breach would signal another test of support at the recent lows of 2830 to 2860.
Selling pressure on blue chips is a lot stronger, with Money Flow on Dow Jones Industrial Average dipping below zero. Reversal below 26800 would warn of a correction.
The investment outlook remains Risk-Off, with last week’s ETF investment flows heavily weighted towards bonds.
Year-to-date flows reflect a similar picture, with fixed income inflows outweighing the much larger equity ETF market.
Supply & Demand
We normally gauge whether stocks are under- or over-priced by comparing earnings to market capitalization, whether in the form of P/E or Robert Shiller’s inflation-adjusted CAPE. But the Fed has shown that stock prices are really a function of supply and demand.
Investment demand skyrocketed in the last decade, with QE driving down bond yields and forcing a large flow of investment funds into equities, searching for yield. The chart below shows estimated market value of publicly-held equity of U.S. domestic (financial and non-financial) corporations and the market value of closely-held equity.
Supply of equities in the same period experienced limited growth because of three related factors. First, GDP growth slowed (partly because of QE). Corporate profit growth then slowed as a result. That left management little option. With limited investment opportunities, they returned capital to investors by way of stock buybacks. That restricted the supply of new equities for investment while demand was soaring.
The result was an inevitable surge in prices relative to earnings.
The chart below compares market cap (above) to corporate profits before tax. I have circled 1987 for comparison.
We remain cautious. Stocks are highly-priced compared to earnings.