On Thursday, the S&P 500, Dow Jones industrial average and Nasdaq all hit record highs for the first time in 16 years. But as stocks march steadily upwards this summer, the number of reasons for caution about this market rally are growing. Here are 12 of them.
1. Despite the hype about the S&P 500 making a new price high, the NYSE composite, Russell 2000 (Small-Caps), S&P Financials, and Dow Transports have all failed to do the same (at least so far). So while the technical picture looks okay, non-confirmations abound.
2. Market positioning is too bullish. There is a net speculative long position of 26,809 S&P 500 futures & options contracts on the Chicago Mercantile Exchange – essentially the most bullish positioning since the week of Jan. 6, 2015, just as the market was about to tilt downward. Not just that but there is a soaring – in fact record high – net speculative long position on the Dow of 38,382 futures & options contracts.
3. Market Vane bullish sentiment shows 61-per-cent bullish on stocks, near the highest since Nov. 6, 2015
4. The latest Investors Intelligence poll shows the bull camp expanding to 54.3 per cent from 42.9 per cent last week; and the bear share receded a touch to 20.9 per cent from 21.2 per cent. So the bull-bear spread has widened to 33.4 per cent from 31.7 per cent last week to stand at the highest level since early 2015, just before the market hit a high that would take 15 months to re-attain.
5. Valuations have reached extremes for the cycle. At 21x last year's earnings and 18.5x 2016 earnings. Not a bubble, but quickly approaching the one standard deviation line. The level of High-Yield spreads suggest a fair-value closer to 17x to 18x earnings.
6. This market is de facto pricing in a 25 per cent earnings bounce (based on historical average multiples) in the coming year which history tells us is about a 1-in-10 event.
7. In fact, since the earnings recession began in the fourth quarter of 2014 – it has been six quarters long now – operating earnings-per-share have declined 20 per cent but the S&P 500 has managed to advance nearly 10 per cent. This by no means suggests an overpriced stock market cannot get pricier – it is only to say that the market is discounting an earnings stream that is highly unlikely to materialize – this multiple only makes sense if you are willing to pay today for an earnings stream we likely will not see until 2018 at the earliest.
8. It should also be duly noted that the per share data have been skewed by the rampant stock buyback environment we have been in for some time – the share count for the S&P 500 is on track for its first annual decline since 2011 (after companies in the index bought back $161.4-billion in the opening three months of the year, the second largest quarter for such activity on record. It remains to be seen whether corporate demand for stocks will remain this exuberant with multiples rising to their current stretched levels).
9. Looking at the actual dollar of earnings, operating profits over the last four-quarters ending in Q1 of 2016 stand at $865-billion, which is down 12.5 per cent from year-earlier levels and 15 per cent from the cycle peak; and not just that, but Q1 2016's profits are actually now lower than they were in Q2 2007.
10. Reported earnings stand at $211.15-billion in Q1 of 2016 which marked a level lower than in the Q3 of 2006 – 10 years of earnings stagnation – when the index was flirting close to 1,300.
11. After a brief three-month stretch of increases in bottom-up analyst revision ratios for S&P 500 earnings, which helped carry the major averages to new highs until recently, these ratios fell back significantly in July. The three-month earnings-per-share revision ratio slipped back to 0.91x from 1.02x in June.
12. The VIX is 11, highlighting an extreme degree of complacency. At this level, history shows S&P 500 returns to be, on average, +0.9 per cent in a one month span and +3 per cent over three months. This is the exact mirror image of what happens when the VIX is closer to 30x, when returns are closer to +3 per cent on a one-month basis and +9.4 per cent on a three-month basis. Discipline means always buying the fear and selling the greed. On a scale of one to 10, we are at eight. So start scaling back.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.
David Rosenberg