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Wednesday, March 25, 2015

Daily update 3/25 Valuations and future returns.


Breadth was -71% and volume increased considerably.  New highs dropped down to only 84.  New lows remained tame at 13.  That suggests they were selling stocks closer to their highs then their lows.  Needless to say today turned the short term trend down again.  I am getting dizzy from changing it.  Up, down, up, down ...  While many people like to say the market is still in an uptrend the underlying action says differently.  This is not an up trend.  The market is dealing with issues and there are people on both sides of the trade.  Today the bears won.  I noted a distinct lack of buying enthusiasm the last two days.  Today was the result.

This morning the futures confirmed the red bar from yesterday with a lower close.  This afternoon they plummeted all the way down to the 200 SMA.  The -DI line has not gotten up to 35 yet, but it doesn't need to.  Since SPX did not make a new high the door to a bigger sell off is already open.  The FED meeting induced move has now been retraced as they so often are.  However, that left us with a chart clearly in bear mode. 

SPX closed on the low which normally means a gap up tomorrow would have high odds of retesting today's low.  The TRIN was only 1.12 on the close so this is unlikely to be a swing low.  My best guess would be that we visit the 100 DMA yet again.  Keep in mind that we have already bounced off it four times this year with only one new high in SPX so far.  That could easily dampen the enthusiasm of those that have been responsible for those bounces.  Should SPX fall through that MA then the 200 SMA becomes likely.  On the upside I don't have anything for you.  The market has some work to do to get bullish again.

I ran across an interesting article with a slightly different historical look at valuations.  On My Radar: Investors Behaving Badly

What the Percentage of Household Equity Ownership Tells Us About Probable Future Returns
Here is how you read this chart. First, the blue line shows the percentage of household financial assets invested in equities. The dotted black line plots the actual rolling 10-year returns of the S&P 500 Total Return Index.
Correlation measures how closely the market’s rolling 10-year returns follow the Household Equity Percentage. A correlation of 1 is a perfect match. A reading between 0.80 and 1.0 reflects a very high correlation. You can see it visually in how closely the dotted black line follows the blue line.
The red arrow at the top of the charts shows the ownership at the market peak in 2000. The left vertical scale shows that households had 65% of their money invested in equities at the market peak in 2000. It accurately identified the 10-year period of negative returns that followed.
The smaller red arrow marks the percentage of equity ownership at the market peak in 2007. Same story.
Take a look at the green arrow at the market bottom in 2009. Great annual returns followed but were individual investors prepared to seize that opportunity? Then, fear in the air was palpable.
The orange circle shows where we are today. Expect low forward returns, be risk focused, stay tactical and patient – a better buying opportunity remains ahead.
This chart shows 10 year returns estimated to be slightly more then 2% per year.  That is inline with models from John Hussman and Jeremy Grantham.  While correlation may not imply causation when the correlation coefficient over a 50 year period is 0.94 you might have some causation involved.  A lot of good stuff has already been priced in.

I find this next chart pretty interesting also.

This chart shows several things.  After the bubble in 2000 the near 50% drop in SPX into late 2002 did not really scare people.  This is similar to what happened in the 1960s and 70s.  The second bear market in both instances caused considerable fear.  What is really different today is what happened after the 1974 bottom when compared to 2009.  Back then investors lost trust in the market and stayed fearful for over a decade.  After 2009 faith in the FED completely erased all the fear from the 2008 crash.  We are now back to the second highest equity allocation in the last 60 years only being surpassed by the 2000 bubble.  According to the table on this chart returns should be negative.  However, I did not see the time period specified in this chart or the article.  I don't know if those are 10 year returns or what.  Needless to say this is likely the second worst time in the last 60 years to invest money for the long term.

I think I have shown charts like this before based on SPX. 

Based on revenue the average SPX stock has not bee more over valued in the last 50 years.  Most valuation models I see are done on SPX.  This next one is on all the NYSE stocks.


This chart indicates the broad stock market is the most over valued it has been in the entire history of doing this calculation.  While the SPX P/E was way higher in 2000 then it is now that was driven by a fairly small number of companies at exorbitant prices.  It could be argued the broad market is more over valued now then it was then.  While there was no forward returns with this chart I can tell you that there were significant sell offs after 1962, 1969, and 1998.  The market paused in 2005 then continued up into 2007.  As they say valuation does not matter until it matters. 

Here is an interesting article on what happens to stocks during recessions based on valuation before the recession started.  Equity Valuations, Recessions and Stock Market Declines  This table is very insightful.

It is pretty clear we are in a position where there is significant downside risk in the next recession.  Most economists think that is still well off in the future.  However, most economists never know we are in a recession until 6-12 months after it starts.  The 1973-74 bear market was caused by the oil embargo and major oil price shock.  That was the only time the market went down over 30% from a not very high starting valuation.  I would call that a black swan event.  The crash of 87 is not in the table because there was no associated recession.  That was also a black swan event caused by portfolio insurance.  Unless we never have a recession ever again it is very likely there is another crash waiting to happen.  We live in interesting times.  Some would say a little too interesting.


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