Published August 10, 2018
While the overall picture for stocks remains decidedly positive, we were struck by a building wall of worry in the two article reprints below this week (both from reporters at Marketwatch.com). Of course, the wall of worry provides fuel for further stock price increases as the skeptics give in to the bulls. But the worriers might just also be the first few to see the cracks in the market foundation that others are not paying enough attention to. Time will tell and our models will be ready either way to guide us. Herewith a note from Marketwatch’s Sue Chang mapping out similarities between today’s market and the dot.com bull of the late 1990s:
“A lot has changed since the stock market crash of 2000. Apple Inc. has gone from being just another computer brand to becoming the most valuable company in the world, Amazon.com Inc. went from being an e-book retailer to a byword for online shopping and Tesla’s Elon Musk has risen from obscurity to Twitter stardom.
Yet some things never change and Doug Ramsey, chief investment officer at Leuthold Group, has been on a mini-campaign highlighting the parallels between 2000 and 2018.
Among the numerous similarities is the elevated valuation of the S&P 500 then and now, which Ramsey illustrates in a chart that he has dubbed as the “scariest chart in our database.”
Chart 1: Price/sales ratio rises to match dot.com peak
Recall that the initial visit to present levels was followed by the S&P 500’s first-ever negative total return decade,” he said in a recent blog post.
Price-to-sales ratio is one measure of a stock’s value. It isn’t as popular as the price-to-earnings ratio, or P/E, but is viewed as less susceptible to manipulation since it is based on revenue.
He also shared a chart which he claims is “unfit for a family-friendly publication” that shows how in terms of median price to sales ratio, the S&P 500 is twice as expensive as it was in 2000.
Chart 2: Median price/sales rises to new high
“Overvaluation in 2000 was highly concentrated; today it is pervasive, with the median S&P 500 Price/Sales ratio of 2.63 times more than double the 1.23 times prevailing in February 2000.”
In a follow-up post, he then reiterates how 2018 is starting to increasingly look like 2000.
“The statistical similarities between the two bulls are on the rise, and the wonderment surrounding the disruptive technology of today’s market leaders seems to have swelled to maybe 1998-ish levels,” he writes.
That upward trajectory of the market isn’t sustainable, he warns. Ramsey admits that history isn’t the best guide for the future but the S&P 500’s performance since it touched its peak on Jan. 26 is closely mirroring what happened 18 years ago.
“In the earlier case, a volatile five-month upswing that began in mid-April ultimately fell just a half-percent short of the March 24th high by early September. This year, a similarly choppy, six-month rebound has taken the S&P 500 to within 1% of its January 26th high,” Ramsey said.
Chart 3: Same look different result?
There are other resemblances such as healthy breadth as denoted by the uptrend in the daily NYSE Advance/Decline Line while corporate profits, measured by Leuthold’s internal earnings indicator, are extremely robust, according to Ramsey.
But even without 2018 mimicking 2000, the persistent trade clash between the U.S. and its trading partners that in the worst case scenario could derail global trade looms as a huge threat to stocks.
China is expected to levy tariffs on $60 billion of U.S. goods if the Trump administration proceeds with its plan to impose 25% tariffs on $16 billion in Chinese imports later this month.
On Aug. 22, the market will officially become the longest bull market in history. Coincidentally, the previous titleholder is the decadelong one that gave up the ghost when the tech bubble burst in 2000.”
Second, some analysis from MorganStanley via Ryan Vlastelica, also at Marketwatch.com:
“For years, one of the primary factors lifting the U.S. stock market has been the fact that some of the economy’s biggest, fastest-growing names just kept rising.
The strength of growth stocks, in particular some large technology and internet plays, has been a boon for momentum investors, who bet that recent outperformers will continue to do better than the overall market over the medium term. This trade has been one of the easiest ways for investors to make money, but analysts are increasingly concerned that its era may be drawing to a close.
Morgan Stanley called for “a breakdown in both legs of momentum,” which it warned “could be a trigger for a significant market correction.”
It’s “hard to walk with two broken legs,” it noted in a note to clients published earlier this week.
Major indexes have been trending higher of late; the Dow Jones Industrial Average recently closed at its highest level since February while the S&P 500 has risen for four straight sessions and is now near record levels. The Nasdaq Composite Index is within 1% of record levels.
While recent price action has been positive, however, Morgan Stanley is concerned about how breadth — the number of stocks rising compared with the number falling — was diverging from price.
“Fewer stocks are carrying the load of the market, a sign of exhaustion and, in our view, a bad signal for further price gains,” the investment bank’s team of analysts wrote. It added that a recent example of a major stock hitting a notable milestone for strength — Apple Inc.’s market capitalization cresting $1 trillion — “sure sounds like a ‘ringing of the bell’ to us.” Rather than the $1 trillion valuation being a sign “that all is right with tech,” Morgan Stanley wrote, it “could be a meaningful historical market for a tradable top.”
This chart compares the number of Nasdaq stocks hitting 52-week highs with the index’s price. While the price has been trending higher, breadth has generally been weakening.
Chart 4: Fewer new highs will lead to a decline in the index?
Morgan Stanley has turned decidedly pessimistic about the U.S. stock market of late, anticipating a “rolling bear market” that hits different parts of the market at different times. Last week, it said the bull market could be in its “last innings” if bears went on to target areas of the market like small-capitalization stocks and the technology sector, both of which Morgan Stanley. Recent signs of weakness in the market, it wrote, could result in the biggest market selloff in months.
While tech and internet stocks are the most visible “mo-mo” plays, Morgan Stanley said this trend was showing signs of deteriorating regardless of market sector.
Sector-neutral momentum has been breaking down due to the outperformance of defensives and weakness in growth, it wrote. “Given the exposure of both discretionary and quant investors to the momentum factor, lingering weakness here can feed on itself and invite further rotations, which will not be good for price momentum leaders — i.e. Tech and other leading growth stocks — or the market.”
Chart 5: Defensive market sectors have been outperforming
Morgan Stanley is not the only firm sounding caution about momentum trends. According to July data from S&P Dow Jones Indices, the S&P 500 momentum index had outperformed the unadjusted S&P 500 by 15% on a total-return basis since the start of 2017. The firm wrote that this degree of outperformance “has rarely been exceeded historically and, when it has been exceeded, has tended to predict a subsequent period of weakness for the strategy.”
The last time the momentum factor saw such excess returns on an 18-month basis was in early 2008, as the financial crisis began to pick up steam. After peaking, momentum’s performance relative to the S&P 500 turned sharply lower, and didn’t bottom until mid-2010.
But other analysts see Wall Street as primed for a breakout.
In late May, the Wells Fargo Investment Institute also used the image of a broken limb to describe the stock market. However, it suggested that the correction major indexes underwent in early 2018 represented the breaking of the “bone,” and that the lengthy rangebound trading since then — the S&P only recently exited correction territory, while the Dow hasn’t yet risen 10% from its correction low, making for its longest stint in correction territory since 1973 — represented a healing of the injury.
At the time, the Wells Fargo Investment Institute wrote that the leg appeared to be nearly healed, citing positive technical trends, like the S&P 500 holding above its 200-day moving average, which it has continued to do as it trends higher.”
Whether the market glass is half full with more upside remaining this year, or whether the market is on its last bullish legs, we are enjoying the strong participation of our subscribers in the solid returns thus far in 2018. We expect to continue being on the right side of the market’s trend going whichever way it moves.
Market Update
The S&P 500 saw its five week winning streak come to an end Friday, but only barely so. The week started well. A largely positive Monday session yielded a +0.4% gain on little new information but carrying forward the recent positive momentum. The trend led to another +0.3% advance Tuesday leaving the S&P 500 ETF (symbol: SPY) finally rising above its January high. The index has spent six months recovering from its first significant correction in two years. With quarterly earnings reports mostly delivered now, stocks appear to be just continuing their recent trend. Wednesday offered little to traders in a flat session as volatility (measured by the VIX index) tumbled near the 10 level usually associated with substantial market complacency/confidence. Thursday offered another flat trading session with the Nasdaq posting an eighth straight session in the green, albeit slightly. However, investors were jolted awake Friday with the Turkish currency plunging -16%. The Trump Administration squeezed the situation by raising tariffs on some Turkish metal imports. The shift in currency values created concerns about European bank exposure to Turkish loans and companies, sending shares in European banks sharply lower. Adding to the negative tone on the day was a downgrade of semiconductor company Intel (INTC) in response to issues raised in their earnings report from last week. Stock indexes closed Friday off -0.7% while international indexes slid -2%.
Friday’s decline offset the gains earlier in the week to leave the S&P 500 down -0.16% – its first weekly loss in six weeks – while the Nasdaq 100 (QQQ) managed to remain positive by +0.24%. The more domestically-focused small-cap stock index, Russell 2000 (IWM), added +0.69%.
Warm wishes and until next week.