Danger lurks as extremes become the norm 01-13-17 _ ria
There have been a litany of articles written recently discussing how the stock market is set for a continued bull rally. Rose quotes While Trump was initially expected to be extremely bad for the market, post-election he somehow became extremely good for it. Aud to usd conversion rate The are some primary points in common among each of these articles which are: 1) interest rates are low, 2) corporate profitability is improving, 3) oil prices are rising, and; 4) Trump’s fiscal policies will supplant the Fed’s monetary policies.
While the promise of a continued bull market is very enticing it is important to remember, as investors, that we have only one job: “Buy Low/Sell High.” It is a simple rule that is, more often than not, forgotten as “greed” replaces “logic.” It is also the simple emotion of greed which fosters exuberance and extremes which ultimately reverts into devastating losses.
Therefore, if your portfolio, and ultimately your retirement, is dependent upon the thesis of a continued bull market you should at least consider the following charts which are a collection of current “extremes” in the market.
It is often stated that valuations are still cheap.
300 us in canadian The chart below shows Dr. Usd graph Robert Shiller’s cyclically adjusted P/E ratio. 10 in binary code The shaded area is the current deviation of P/E’s above or below their long-term median P/E.
Currently, valuations are pushing levels only witnessed in 1928-1929 and 2000. Euro to pound sterling exchange rate However, it is often suggested the current valuations are nowhere near the “dot.com” level so obviously stocks are just mildly overpriced. Aud usd exchange rate The problem is current valuations only appear cheap when compared to the peak in 2000. In order to put valuations into perspective, I have capped P/E’s at 25x trailing earnings as this has been the level where secular bull markets have previously ended. Dollar exchange rate today I have noted the peak valuations in periods that have exceeded that level.
With valuations at levels that have historically been coincident with the end, rather than the beginning, of bull markets, the expectation of future returns should be adjusted lower. 1 usd in inr This expectation is supported in the chart below which compares valuations to forward 10-year market returns.
I have often compared market prices to the equivalent of “stretching a rubber band.” Prices can only deviate so far from the long-term trend line before a mean reverting event eventually takes place. Dollar vs euro chart Much like a “rubber band,” prices can only be stretched so far before having to be relaxed to provide the ability to be stretched again.
The chart below shows the long-term trend in prices has compared to its underlying growth trend. Current exchange rate usd to cad The vertical dashed lines show the points where extreme overbought, extended conditions combined with extreme deviations in prices led to a mean-reverting event.
This is shown a bit clearer below which compares the deviation of the S&P 500 from the long-term growth trend. Usd today Currently, while only slightly below the peak of the 2000 “dot.com” bubble, the deviation is at levels that have ALWAYS coincided with a negative mean reverting event or very poor, and highly volatile, forward returns.
Another argument I hear made consistently is that retail investors are only just now beginning to jump into the market. Ringgit usd exchange rate The chart below shows the percentage of stocks, bonds and cash owned by individual investors according to the American Association of Individual Investor’s survey. Stock market meanings As you can see, equity ownership and near record low levels of cash suggest that the individual investor is already likely “all in.”
When we look at the levels of Margin Debt/GDP ratio as compared to the S&P 500, we find a high correlation between peak levels of debt and subsequent market returns. Kurs usd ke rupiah Not surprisingly, extreme levels have been more indicative of “ends” rather than “beginnings.”
As detailed recently by ZeroHedge, according to DB’s calculations, the net short Treasury position is now a four sigma event, having grown to nearly four standard deviations away from mean, even after adjusting for open interest.
Bob Farrell’s rule #9 states that when everyone agrees; something else is bound to happen. Exchange rate us to canadian dollar The next two charts show the level of “bullishness” of both individual investors (AAII Survey) and professional money managers (MarketVane, NAAIM & INVI Surveys). Samsung washing machine codes Surprisingly, investors are currently more exuberant than just about at any other time on record.
If we smooth the index with a 4-week average we get a better view of the current level of exuberance. Convert indonesian rupiah to usd Importantly, such levels of exuberance have been historically, once again, associated with short to intermediate-term, or worse, corrections.
While I am not suggesting the markets are about to crash tomorrow, I am suggesting that future returns are likely to be much lower than currently estimated by the majority of the financial media.
As a money manager, I am currently long the stock market. Binary tools I must be, or I potentially suffer career risk. Futures market cnn However, my job as a portfolio manager is not only to make money for my clients, but also to preserve their gains, and investment capital, as much as possible. Msn news usa Understanding the bullish arguments is surely important, but the risk to investors is not a continued rise but rather the eventual reversion that will occur.
Unfortunately, since most individuals only consider the “bull case,” as it creates confirmation bias for their “greed” emotion, they never see the “train coming.”
Currently, with everyone on the “same side of the trade,” any exogenous event which triggers a movement in the opposite direction tends to result in a stampede. Hopefully, these charts will give you some food for thought.
“In ‘ The Problem With Forecasts,‘ I noted the Dow is currently working on completing an advance of 5000 points over a 24-month span. Nzd usd live chart The last time such a compressed advance occurred was during the 1998-1999 period.
“Following the 1994 market lull, the S&P 500 began its first serious bull market advance as a wave of investors flooded into the market due to the introduction of online trading and the official opening of the “Wall Street Casino.” From 1995 to its peak in March of 2000 the market advance (whole number basis only) by 1000 points over that 60-month period.
Following the crash, investors reluctantly began to return to the markets in mid-2003. Dollar exchange rate in india As the Federal Reserve, and deregulation of Wall Street advanced, so did investors speculation in the markets as a real estate sub-prime lending took hold. Usatoday com news Beginning in 2003, the market began a 60-month trek higher of 700-points before once again finding the limits of “fantasy and reality.”
So, here we are once again. Trading places stock market scene Over the last 60-months the markets have advanced by 1100-points, and 1400-points over the last 84 months, as Fed-induced monetary stimulus and suppression of interest rates have once again led investors to believe “this time is different.”
Throughout history, as shown in the chart below, prices have ALWAYS, and I repeat ALWAYS, eventually found their limits. Convert aud to usd There has never been a “permanently high plateau” that inoculated investors from devastating consequences of misconceived and poorly managed investments.”
Not surprisingly, given the period of advance without a 1% decline, which has pushed prices to an extreme deviation above the 200-dma, the volatility index has dropped to levels that have historically denoted short to intermediate-term market peaks.
On a very short-term, daily, basis, the market registered a “sell-signal” from a very high level, something I discussed several times previously. Inc connector While such a sell-signal does not always translate IMMEDIATELY into a correctional process, it has done so, particularly from these levels, more often than not.
With Trump’s inauguration next week, and an immediate flurry of action promised within the first 100-days, there is a significant degree of risk that an action, combined with extremes of the market as discussed above, could send market participants running for cover.
Next week is another holiday-shortened trading week, with the awaited inauguration of President-elect Donald Trump on Friday. The markets have continued to mostly tread sideways since the beginning of the year as uncertainty around the new President’s potential actions weigh on risk-taking.
“With buy signals on all three indicators registered currently, any corrections are likely to be somewhat limited back to the rising short to intermediate-term moving average. Usd news This would suggest a correction back to 2200 would likely be a “buyable” trading level. Binary dictionary As noted in the chart above, the current extension above the moving average will likely be corrected in fairly short order and we can use that correction to rebalance allocation models for the beginning of this year.”
As noted in the main body of this week’s missive, the current extremes on many fronts suggest investment risk remains elevated which is why I have not increased the allocation model to 100% as of yet. Us stock market futures contract This is also why I have suggested over the last couple of weeks to use this current advance, and extension, as an opportunity to clean up portfolios. Funny quotes about life lessons (Use guidelines noted previously.)
If we can get a correction that resolves the overbought, extended and excessively bullish backdrop to the markets currently, I WILL increase the allocation model to 100%. Exchange rate mxn usd For now, we will wait and let the markets tell us what it wants to do next.