Warning Signs Continue to Proliferate
The stock market's advance becomes ever more suspect. Even
though a 'blow-off rally' remains a strong possibility in view of
continued monetary pumping, there are a number of factors that
represent extremely strong warning signs and can usually only be
observed in the late stages of a bull market.
There is for instance the narrowing of the rally to a handful of
'story stocks' that trade at ever more absurd valuations and seem
to be able to inexorably rise into the stratosphere, discounting a
glorious future that may or may not eventuate (stocks like
[[AMZN]], [[TSLA]], [[NFLX]], [[FB]], [[CRM]], [[YELP]], [[LNKD]],
[[DDD]], [[PCLN]] and so forth). In many cases valuations have
become so stretched that even if one assumes that the most
optimistic scenarios painted by some analysts and the buyers of
these stocks actually do come true sometime in the next ten or
twenty years, these stocks would still be overvalued.
Similarly, the pace of IPOs has vastly increased. Whereas IPOs
were in 'slumber mode' for much of 2009-2012, issuance has really
taken off this year and is at the highest level since 2007. Not
only that, but many stocks are once again soaring by up to 100% on
their first trading day, which is strongly reminiscent of the
insanity that reigned in 1999 to early 2000.
Another facet reminiscent of both the 2000 and 2007 peaks is the
huge amount of actual and announced stock buybacks (which are often
financed by leveraging balance sheets). These buybacks help
earnings per share to increase even as revenues stall, creating a
Potemkin village of corporate profitability.
In numerous cases all that is achieved by buybacks is the lining
of the pockets of managers, who receive stock options by the wagon
load, leaving shareholders in no better position in the long term
as the stocks issued in these incentive programs are destined to
eventually hit the market. In fact, since corporate leverage is
often increased in order to finance buybacks, shareholders in many
cases will ultimately end up worse off. In the short term everybody
loves the effects of buybacks of course, but be warned: they move
in a pro-cyclical manner, which is to say buybacks tend to peak
when stock prices are near a peak as well. After the 2008 crisis,
many people realized that enormous amounts of capital had been
wasted in the buybacks of 2006 and 2007. This has all been
forgotten again, but we would argue that the same thing is true
today that was true at the time: a lot of the current buybacks will
eventually be revealed as an egregious waste of shareholder
Margin Debt Soars to New Record High
However, if we had to pick out one feature of the Bernanke echo
bubble that is most likely to eventually lead to huge losses for
today's buyers, it is margin debt. As long as margin debt is
rising, it helps the market to sustain its uptrend, as it
represents a big source of buying power.
It becomes a bane though as soon as the market turns down, as it
then produces forced selling and tends to exacerbate declines.
report at CNBC
, NYSE margin debt has soared to a new record high, exceeding $400
billion for the first time ever.
(click to enlarge)
NYSE margin debt vs. the S&P 500 index
As can be seen on the following long term chart of margin debt
by sentimentrader, the negative net worth of investors was only
greater in a single historical instance, namely during the peak
months of the technology bubble in 2000.
In other words, the Fed has 'succeeded' to once again maneuver
investors into a position that essentially guarantees that many of
them will eventually suffer grievous losses. Note that in the event
of a blow-off rally, the margin debt situation is likely to
deteriorate even further.
For more charts illustrating margin debt and investor net worth,
take a look at
this page at Doug Short's 'Advisor
, which also includes charts that are inflation adjusted (i.e.,
adjusted by official consumer price indexes). What is slightly more
easily discernible on Doug's chart page is that margin debt usually
begins to decline a little bit just before the market embarks on a
major downturn. This is valuable information that may prove helpful
with timing the echo bubble's eventual demise.
This also tells us that while we may well be witnessing the
bubble's terminal stage, the end is probably not here just yet.
(click to enlarge)
NYSE margin debt, long term. Investor negative net worth has
only been larger in the final stage of the tech bubble in
Along similar lines, Business Insider
has recently 'discovered'
what it thinks is an 'extremely obscure' indicator, namely implied
Rydex money market fund assets. It may be obscure to BI, but it
isn't to us. We always like to keep an eye on developments in Rydex
funds, as this microcosm of market sentiment has often provided
valuable information in the past. Below is a chart from
decisionpoint that shows not only money market fund assets, but
also the assets currently deployed in bullish and sector funds and
those in bearish Rydex funds.
It is probably no exaggeration to state that bullish sentiment
in terms of positioning remains 'off the charts' (as we have
discussed on several previous occasions, this is also mirrored in
the positioning of speculators in the financial futures
(click to enlarge)
Assets in Rydex funds, via decisionpoint: Bullish and sector
funds hold ten times more assets than bearish ones, money market
fund assets are scraping the bottom of the barrel
The amount of assets held in Rydex money market funds is likely
a reflection of how many investors expect a 'correction' and are
therefore keeping some of their powder dry to buy the expected
bargains once they appear. With these funds at the very low end of
the historical range, it is reasonable to assume that very few
people are thinking about the possibility that stock prices might
actually decline anytime soon. Also, bears are obviously not
especially confident either. While Rydex bear assets have been even
lower earlier this year, the current levels certainly don't
indicate a surfeit of bearishness, especially not when brought into
context with bull assets that are near record highs (note that the
the fact that both stock prices and bear assets are now higher than
earlier this year constitutes actually a bearish divergence).
It is important to keep in mind however that the indicators
discussed above are not really 'timing' indicators (with the
exception we mentioned above, namely an initial decline in margin
debt outstanding close to a peak in the market). One cannot look at
these data and conclude 'the stock market will immediately
decline'. That is not how it works. We have seen on a number of
previous occasions - most notably in early 2000 - that the market
can continue to soar in the short term even after such extremes are
recorded and all these indicators can become even more stretched in
the process. There are however several legitimate conclusions one
- The risk-reward situation in the market is dangerously skewed
toward risk. Investors are skating on ever thinner ice.
- Once the risk becomes manifest, forced selling will
exacerbate the decline in prices.
- The more stretched these indicators become, the closer we get
to a long term turning point.
The stock market keeps levitating on the promise of more money
printing. It remains possible that the advance will enter a
'blow-off stage' - a 'panic buying' type advance during which
prices rise almost vertically, increasing considerably in a very
short time. We keep mentioning this possibility because we know it
has happened in the past when monetary conditions were very loose
(admittedly, they have never been as loose as today, so in a sense
the situation is actually quite unique).
However, keep also in mind that such a 'blow-off' doesn't have
to happen. Whether or not it happens is in any case irrelevant to
the assessment presented above: risk has increased enormously.
Eventually, the market is likely to crash, leaving very little time
for over-leveraged players to save their skins.
We leave you with one more chart that shows the latest
divergence that has developed: while the SPX has made new highs,
these have (so far, anyway) not been confirmed by the DJIA:
(click to enlarge)
The latest divergence: DJIA vs. SPX (green line at the bottom
of the chart)
Charts by: StockCharts, CNBC, Sentimentrader,
Right Now Is The Wrong Time To Be Buying Health