As we stand just a couple of days after the ides of March, the Dow Jones Industrial Average (DJIA) has made a new high, the S&P is nearly at an all-time high, and the NASDAQ is well below its all-time high set more than a decade ago. This article attempts to shed some light on the health of the stock market rally.
Candidly this market has more legs than anticipated after the solid low of 2009. In Escaping Oz, I outlined several reasons why the highs set in 2007 for both the Dow and S&P would not be eclipsed for many years. The extant conditions for that reasoning have not changed. In the spring of 2009, it was all doom and gloom. In my market letter, I suggested a bottom was near and that a strong rally would ensue. That bottom is now four years in the rear view mirror. Does the rally still have power?
During the tops of 2000 and 2007, the “conventional” media was as ebullient as the typical investor. Stories in print and television journalism tend to reflect the popular mood near the end of a trend. I was thus surprised with last week’s issue of The Economist when one of the headlines asked “Is the stock market right?” Let me answer that question with “no”.
There are a number of indicators suggesting an unhealthy bull market. I will classify this market (2009 – present) as a false rally or trap.
- Global media (The Economist) questions the market
- P/E ratios are 39% above long-term average values (per Robert Shiller)
- Q ratio shows a market 50% overvalued
- Dividend yield of S&P is 2.01%, well below its historical average
- Hedge funds are exposed to stocks at record levels
- NYSE margin debt is approaching its all-time high indicating great leverage
These statistics are contrarian indicators. Rather than showing potential, they reveal an aged market. This is a four year retracement within the context of a larger bear.
Let me mention other statistics comparing the country’s economic condition to that of the October 2007 market highs.
- The number unemployed is now 12.3 million vs. 7.2 million in 2007. I am not counting those who are not officially part of the employment rolls since they dropped out.
- Food stamps now assist 47.7 million vs. 26.9 million in 2007.
- Public, funded debt, is $16.7 trillion vs. $9 trillion in 2007.
- Annual deficit rose from $162 billion in 2007 to $1+ trillion today.
- The Fed has swallowed balance sheet assets to the tune of $3.1 trillion vs. $890 billion in 2007. They are committing $1 trillion more in the coming year.
- Negligible GDP growth versus 3.0% in 2007.
We have more unemployed, more unable to feed themselves and a weaker economy. For this outcome government has spent trillions and borrowed trillions. The Fed, meanwhile, is acting as a backstop for the economy by purchasing assets that no one else wants (at least not at the prices paid). The Fed of course does this by artificial credit creation. What happens when the Fed wants to unload those assets?
A more direct representation of the market’s health is evident in slides #1 and #2. Slide #1 is the DJIA (from the 2007 high) with volume statistics under the price chart. I placed red ovals in the volume portion of the chart to represent those periods of highest activity. Note how those periods correspond to market bottoms and not tops. Slide #2 is a magnified version of the volume statistics for the same period as Slide #1. In this slide, I drew a very rough trend line showing decreasing volume throughout the 4 year bear market rally. We are experiencing diminishing market trading with its most active days occurring on the down side.
Another sign of the times is evident when amateurs are cited. When amateurs are lauded, the end of a trend is nigh. In a Yahoo Finance article from February 15th, a 16-year old actress stated she’d been day trading for more than a year while achieving “stellar” returns. More recently, the actress Mila Kunis, was cited for her trading prowess. This is reminiscent, though less so, of the bubble top of 2000 when day trading became popular. It also reminded me of 2005 when the real estate bubble hit. I had a relative that plunged head first into the fray. I knew the trend was over at that point.
Finally, a month ago I penned an article about the gold market’s doldrums and discussed this precious metal’s relationship to the stock market. I postulated that due to the credit bubble, I could not foresee a strong, sustainable stock market with a declining price of gold. Since I wrote that article, gold is slightly lower. This does not bode well for U.S. stocks.
The market rally may have some charge left in it, but it is expending an awful lot of energy in the process. When that energy finally ebbs, there is little to support a prolonged and ferocious decline.
Jim is the author of Escaping Oz: Protecting your wealth during the financial crisis.