FIVE YEARS FROM U.S. STOCK MARKET’S LOW, IT’S JOY VS. WORRY

Valuations: Profit growth, and especially revenue growth, may not be strong enough to support current price levels. Profit growth has slowed considerably from the peaks of this earnings cycle. There are concerns that revenue growth will be lackluster while economic growth remains mediocre.

The S&P 500’s forward price-to-earnings ratio, at 15.8, is its highest since the fourth quarter of 2008, Thomson Reuters data showed. It comes as revenue growth has slowed, eating into profits, and productivity growth declined in the first quarter, suggesting slimmer margins in the next earnings period as well.

S&P 500 revenue growth has averaged just 3.2 percent since March 2009, while earnings growth has averaged 16.2 percent, Thomson Reuters data showed. For the most recent reporting period, revenue growth is estimated at 1 percent while profit growth is forecast at 9.8 percent.

The stock market has seen higher price-to-earnings ratios – notably during the technology bubble and the end of the 2007-2008 run, but to some, that’s not comforting.

“A lot of people say the multiple is not that high, compared to history, but in no time in history, did you have these types of tailwinds pushing asset prices for five years,” said Michael O’Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut. Speaking of which …

 

• The Punch Bowl: The Federal Reserve is steadily removing its bond-buying accommodation that took its balance sheet from about $900 billion to more than $4 trillion in the last several years. The central bank had been buying $85 billion monthly in U.S. Treasuries and mortgage-backed securities. But the Fed announced in December that it would begin reducing that amount. At its current pace, purchases will end by year-end, removing support for lower rates that many say have pushed investors into riskier assets like stocks.

Slow job and economic growth since the 2007-2009 recession has left investors worried about whether the economy and market can stand on their own without the stimulus. And rising rates would have a detrimental effect on borrowing costs, which have been at record lows for companies.

 

• Margin debt: The value of U.S. equities investors bought with borrowed money has been rising since June. Margin debt accounts totaled a record $487.6 billion in January, data from the Financial Industry Regulatory Authority showed. It shows hedge funds and other investors are taking on more risk and using borrowed money to enhance their returns. Borrowing on margin at this level is seen as a sign of overly bullish sentiment.

“To me, this is a very overcharged environment,” said Brad Lamensdorf, co-manager of the actively managed short only Ranger Equity Bear ETF  HDGE.P. “It adds up to a very poor risk-reward ratio for the marketplace.”

 

• Insider selling: Lamensdorf said high levels of insider selling support the idea that the market is overvalued, as those with more knowledge believe it is time to pull back on their own stocks. He said there are 10 insiders selling the company’s stock to one insider buying.

That may be somewhat inconclusive, though. Current data shows the selling bias among insiders is strong, though not at historic levels in terms of volume, said Ben Silverman, director of research at InsiderScore.com, which does not release data for proprietary reasons. He did say the first quarter is when many companies award their restricted stock as part of compensation, which tends to lead to a lot of selling.

 

• Where’s the correction?: The S&P 500 hasn’t seen a 10 percent decline for nearly two-and-a-half years, with the last one coming between June and October of 2011, a period that included a budget face-off that resulted in the first-ever downgrade of the credit rating of the United States.

Stocks fell more than 20 percent in that time period, but since then, there hasn’t been a 10 percent drop on a closing-level basis. (There was a narrow miss in May 2012.) Corrections are generally considered positive because they force investors to defend their bullish positions, and without them, concern about complacency rises.

 

• Sentiment: Bianco Research notes that the weekly Investor Intelligence surveys show just 15 percent of newsletter writers are bearish, below the levels seen at the height of the market in 2007. The percentage of those who are bullish was 61 percent at the end of the year, a level not seen since 2007. That figure, though, has dipped a bit since 2014 began.