- Expectations that the New Administration will drive economic expansion and earnings growth have fueled a powerful rally of the broad market.
- Earnings since 2013 have stalled with no meaningful growth.
- Valuations are now visibly stretched across the board.
- The Fed is on a path to raise interest rates.
- Insider selling shows a massive and broad-based spike.
Here we go - listen to
CNBC, or follow the new twitter hysteria and we have now reached a new
dangerously high plateau...
Since election night, the S&P 500 (NYSEARCA:SPY) has staged a 265-points rally fueled by
expectations that the New Administration will drive economic expansion and
earnings growth. The idea is to attract to the U.S. the production facilities
from abroad that serve the domestic market, as well as bring to America
foreign-based production facilities that serve non-US markets. It is the
so-called "import- substitution-plus" to quote El-Erian's
recent words. The unknown is how such a dramatic shift in policy by
the country "at the core of the international monetary system" will
affect other countries, and the overall global trading system.
We remain skeptical and of the opinion that the
broad market is in dangerous territory. The possibility that the New
Administration will fail to implement "any"
meaningful economic measure is on the rise, with a very real possibility that
policy attempts will be countered by both domestic and foreign opposition. The
widespread reactions to the Immigration ban of the past weekend are a sound
example of what will be the future of policy setting for this Administration.
Earnings since 2013 have stalled with no real
growth, while the market continued to push higher, discounting policy effects
that still need to be implemented and more importantly bear fruits. Overall,
34% of the companies in the S&P 500 (SPY) have reported earnings to date for the
fourth quarter. Of these companies, 65% have reported actual EPS above the mean
EPS estimate. This percentage of companies reporting EPS above the mean EPS
estimate is below the 1-year (71%) average and below the 5-year (67%) average.
In fact, if the index reports earnings growth for Q4 this year, it will mark
the first time the index has seen year-over-year growth in earnings for two
consecutive quarters since Q4 2014 and Q1 2015.
Valuations are now visibly stretched across the
board. Our proprietary models indicate that the market is about 20%
overvalued. The comparison of the Rate of Change for both the S&P 500 (SPY) and its earnings shows exactly how the
broad market has gone into bubble territory. The market's multiple expansion promoted
at the time by Fed intervention through its QE Programs has now, with Trump's
election, reached a level that should at least suggest caution. The current Shiller PE is at 28 or 23% higher than its long-term
mean. We get the same picture using the forward 12-month P/E ratio for the
S&P 500 (SPY) which currently stand
at 17.2. This P/E ratio is above the 5-year average (15.1) and above the
10-year average (14.4).
Source: Agon Research LLC
The Fed is also on a path to raise interest rates, which will make
the equity risk premium less attractive, leading to an increased pressure on
stock valuations and other riskier assets. Higher rates will also lead to
reduced stock buybacks, dividends, expansions and mergers, which in the past
few years have fueled the market to the tune of some $500 billion per year.
Our
base case scenario is two 25 basis points rate hikes this year, in June and
December respectively.
Last
but not least, while U.S. financial stocks have soared in the post-election
euphoria, a massive and broad-based spike in insider-selling (relative to buying) is in the making.
Source: Thomson Reuters
To top it all off, the geopolitical environment is not reassuring.
Europe, China, Russia, the Middle East are all question marks in an
increasingly uncertain international equilibrium.
Maybe
we are just overreacting to a series of material risks. Bulls will certainly
argue that the glass is half full, but we are not in their camp. In fact, it is
our view is that the market is not discounting the risks highlighted here.
The
best advice at this time? "Be Fearful When Others Are Greedy". It is
better to sit this one out than be left without a chair when the music stops.
