Jack Nicholson – “As good as it gets”!
Here at Titan we made a bold call just over a week ago when Gold was trading around $1290/oz, stating that we had gone maximum bullish on Precious Metals stocks. Over the ensuing week the sector rallied by over 10% and it’s safe to say that we “made hay”. We remain steadfast in this view.
Today, on the back of what I perceived to be the final “siren call” on the run from 1650 on the S&P 500 (which incidentally we also flagged as being a floor by us to the day), we complete our short overlay on our Global Macro portfolio ahead of the FOMC meeting conclusion tomorrow.
Just what is this siren call you may ask? Well, an old friend whom I respect immensely, came out of with the following statement – “It’s a bull market, forget about the reality just now!”
Of course, our investment strategy is not based solely on attempting to trade against a friend (!) but, in unison with a plethora of other signals which we will lay out below, we are unsure just where the next layer of speculative froth comes from to take the market higher.
Here’s our check list as to why we believe the odds are now firmly stacked in our favour on the short side –
1. It seems that we are pretty much a lone voice calling for a shakedown (always a comfortable place to be) at present. From contributors at SBM such as Dominic Picarda, Zak Mir etc to colleagues in the market, it seems they are all getting washed up in the heady environment of easy money that is being made. Well, as we have relayed numerous times before, making money in the market is not supposed to be “easy” and when it is the game is usually up.
2. See the table below which is the AAII’s measure of bullishness relative to bearishness. The current differential of over 30% is in the top decile and such a figure has an historically high success rate of calling market tops. Of course it doesn’t call it to the day (remember nobody ever rings a bell at the top or bottom, one can only use judgement!) but it is typically within weeks of the peak. It will be interesting to see what the next couple of weeks figures look like.
3. The deviation of the S&P 500 from its 37 week exponential moving average (see chart below over last 10 years) has reached approx 10%. Whenever the market has been stretched to this degree, certainly over the last 10 years, we can see that there has always been a snap back causing the index to revert to the average and actually undershoot it. This would take us to around 1600.
S&P 500 10 year weekly chart
4. We offer up another chart that records the level of margin debt in the US. We can see that it has now take out the peak prior to the severe bear market of 2007-09. A very ominous sign as it means IF a catalyst comes out of the blue that knocks the market that there will be quite a bit of forced exiting occurring when the dreaded “Mr Margin” comes knocking.
5. The CBOE Put/Call ratio is probably one of my all time favourites for certainly calling a market bottom, and I have successfully called the last 2 intermediate bottoms in the US using this ratio and as detailed on this blog. The ratio is slightly more delayed on the bull side peak signal and although not presently positioned in the real extreme territory signaling excessive optimism, when coupled with the low vix measure, it is hard to argue other than complacency is presently at play. Of course it generally pays to buy when there is worry around and not complacency…
The chart below shows, aside from the September “taper” shakes, that this ratio has been trending lower in recent months and is now approaching its 3 year lows. This is something to watch for a spike below 0.5 over the next few weeks as a real sell trigger in our opinion.
6. Finally, we come to valuation. The enthusiasm created by the Federal Reserve and its QE 3&4 “incentive packages” have pushed investors out of the deemed “safer” fixed interest assets and finally into the riskier stock market, arguably at the peak as recent mutual fund flow stats from the US show investors there embracing equities, ironically after they have nearly tripled!! Of course, the retail were mass were net sellers up until this year of equity mutual funds.
If QE has been questionable in terms of growth and employment, it certainly isn’t in terms of stock gains produced as the S&P 500 now up on the year a shade over 24%, whilst the small cap laden Russell index is up 33%.
The problem with this bull market is that, aside from the stock price increases, underlying earning have not risen to support the prices. Essentially PE multiples have expanded. Sales, margins, and earnings have not grown enough to support the new valuation plane.
Recurring margins have in fact collapsed to their lowest level in 3 years, and which of course negatively impacts the sustainability of higher price multiples. Sales per share growth is another indicator failing short of expectations. It bottomed in 2009 at negative 15% as sales slumped with the financial crisis, recovered significantly until 2012, and is now heading back towards flat line.
So, we have a fundamental backdrop that is taxing the minds of some of the worlds most respected minds – Faber, Fink, Gross etc who all look at the madness of the Fed’s current policy and continue to pull cash from the market. Even the Norwegian sovereign fund came out earlier this week and said they were reducing their equity exposure due to valuation concerns.
It seems that under this massive quantitative easing program that investor’s perceptions are being distorted and they are being forced into potentially wrong decisions. Simple fact is that if the FED stopped buying Treasuries, interest rates would rise. Bond prices would be pushed down and in all probability stock prices would correct as the bond:equity yield support measure gets eroded even more and another justification for current equity prices is kicked away.
The following table shows P/E ratios for a few American indicess. Look at the change that has been experienced in just one year. The S&P 500 index shows a 13% increase on its P/E while the Russell index experienced an unbelievable 170% increase.
All this explains why 4 out of 5 valuation methodologies used by our friends “Squid” at Goldman Sachs now point to stock market overvaluation. Their US Portfolio Strategy DDM, ROE and P/B Relationship, Macroeconomic Regression, and CAPE P/E models are all showing overheating, with the FED model (cough, cough!) being the only methodology still showing upside potential. That’s exactly where the problem resides. The FED and its models aren’t able to identify the bubble because they are creating it! The saying “blind leading the blind” springs to mind..!!
Here at Titan we are building our short position, through both futures and option strategies. If you’d like more details on our funds and how you can participate then click the image below to visit our site or email us at info@titanip.co.uk with any questions.
Spread betting involves the use of leverage and so could result in losses of some or all of the funds invested.