Where are we in this market cycle?
There seems to be two views.
The Bear Case
1) A bubble about to pop
The Bull Case
2) This is the beginning of a generational bull market.
In this post we will look at the bear argument and then I will give you my gut feeling. Being any more confident than that would be attributing skills I do not have to my forecasting ability.
A Bubble About to Pop
In their Feburary report State Street Global Advisors presented the following chart showing that this current bull market (based on the date they believe it began – more on this later) is longer than the average and the second longest in history.
In addition to an extended age the percentage of companies with negative earnings is increasing. This metric peaked 2-3 years prior to the last two large market drawdowns. This metric peaked in 2014 and if it repeats its forecasting accuracy then 2017 should be the top.
Dana Lyons in an article entitled Are Investors Running out of Cash presented the below chart. The market has a tendency to decline when the percentage of cash in accounts falls below 15%.
Trader and newsletter writer (the Daily Dirtnap and Street Freak) Jared Dillian in a post entitled When It’s Time to Leave the Party (an excellent post by the way) warns that the top may not be in but provides some excellent sentiment contrarian ammunition such as 1) Jay-Z launching a Venture Capital Fund and 2) Pitbull speaking about stocks and real estate at investment conferences. The sentiment argument is the famous Joe Kennedy quip that he knew it was time to exit his investments when he started receiving tips from his shoe shine boy. I like the sentiment argument, but it is a hard one to use for market timing and often is a hindsight indicator. Dillian is not arguing for an immediate top, but discusses that it might be time to just stand aside regardless of direction.
Confluence Investment Management looked at a chart of drawdown percentages and it is clear the market rarely has ever gone this long with out a large decline
They also presented a chart comparing the current cycle with the average first year Republican president – presidential cycle. Both charts argue for future weakness.
Jesse Felder invokes the Buffet rule to show how future returns tend to be disappointing when valuations are at the current level.
Rydex Sentiment, measured by the asset ratio (the bear fund + money market assets divided by the bull fund) is quite optimistic and starting to roll over.
Shillers CAPE (Cyclically Adjusted PE) which uses 10 year rolling average corporate earnings to calculate the PE ratio is the third highest on record. Shiller has proclaimed that CAPE is not a good timing indicator but as a measure of value it is getting extended.
The spread between black unemployment and white unemployment is reaching levels where previous recessions/market peaks have occurred. Arguably the forecasting ability of this metric could have changed, due to less racism (I said could have, not has) but it is suggesting the labour market is tight.
Tom McClellan produced the next chart. It is the oil price overlaid the S&P chart in log format with the S&P 10 years behind. The chart appears to show that major oil price peaks are 10 years in advance of the S&P and the last major oil peak was in 2008. If this chart is true, then 2021 will also be a difficult year for equities.
Invesco published the below chart to explain the phases of the credit cycle. Assuming this cycle is the same many of the metrics are in the late cycle phase.
Speculative grade defaults are at the highest since 2009 with the global percentage increasing from 2.8% to 4.5%. This appears to be in the late cycle to recession category.
US corporate profit margins have been plateauing over the past few years fitting into the late cycle category.
US CAPEX has been weak this entire cycle and certainly affected by the decline in energy sector CAPEX, which is now increasing. CAPEX has increased year over year but had been falling since 2014. This fits with in the recession to early stage cycle.
US merger activity in the first half of 2017 increased in the number of deals but declined in value. This falls with in the late cycle category.
Corporate stock buy backs declined approximately 18% in the first half of 2017 vs. the same period in 2016. This would appear to fit the recession category.
The cash position of US corporations has continued to expand in early 2017. This would fall in the mid-cycle portion the chart.
Most of the metrics Invesco uses to describe the credit cycle fall in the late to recession category.
According the opinions of the above market commentators the length of this cycle is extended and valuations are higher than normal. The market is much overdo for a decline of 10-20% (or more depending on the commentator). This cycle has to be near its end.
The above chart which shows the history of prices during the South Sea Bubble is what I have chosen to use to show where I think the market is in the cycle. My gut feeling is that there is still 25% more upside which equals 27,500 for the DJIA. Be nimble if you plan to ride the rest of the bubble. A good tell will be when the Advance Decline line peaks and the year over year change in margin debt goes parabolic and is above the 50% growth rate followed by a declin.
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