Monday, August 19, 2013

Profits are Falling – The Stock Market Will Follow

“…This quarter, like some recent quarters, the Dow Jones Industrial Average has both negative earnings per share (EPS) and negative revenue growth as compared to last year. The Dow Jones Industrial Average has actually been contracting for the past 12 months on a revenue basis, with barely any EPS growth whatsoever….”  Commentary at…

“The best measure of how companies perform for shareholders is a wonkish tool called Economic Value Added, or EVA. The advantage of EVA is that it corrects the gap, so to speak, in regular GAAP accounting by gauging what's really important: whether shareholders are getting returns superior to what they'd garner putting their money in another, equally risky stock or index fund.”

“EVA Dimensions' data shows vividly…that profitability is… dropping sharply. Since 2011, return on capital has fallen to around 8.9% for non-financials, a decline of 1.1 points. It's as if stocks were caught between two powerful pincers that are now inexorably narrowing…[First, ]"Expenses may remain stable, but it's clear companies have run out of room to make major cost reductions," says Robert Corwin of EVA Dimensions.  Second, corporations are suffering a shocking drop in sales growth…

…Let's assume that the 10-year Treasury bond returns to a reasonably normal level of 4.5%. That would drive the cost of capital from the current level to around 7%. Even if the return on capital remained steady at the current 8.9%, stock prices would drop by 25%.”  Story from Fortune at…

The above story on EVA is just another way of saying what numerous pundits (FactSet, Cramer, Hussman, Saut, et al.) have stated recently: Profit margins are falling.   That is bad for the markets.

“…At present, we have what might best be characterized as a broken speculative peak, in that market internals (particularly interest-sensitive groups), breadth and leadership have broken down uniformly following an extreme overvalued, overbought, overbullish syndrome. If you recall, the market also recovered to new highs in October 2007, weeks after the initial, decisive break in market internals at that time. Presently, we’re looking at the same set of circumstances. On some event related to tapering or the Fed Chair nomination, we may even see another push higher. It isn't simply short-term risk, but deep cyclical risk that is of concern. ..
…Our estimates of potential market losses are surging, and our present return/risk estimates easily fall into the worst 1% of historical data. We associate these instances with average losses in the S&P 500 approaching 50% at an annual rate, though a scattered handful of similarly weak estimates since April 2012 have been devoid of any negative outcomes at all.” - Excerpts from the Weekly Market Comment for 19 August 2013 by John Hussman, PhD.  Full commentary from Hussman Funds at…

From 10Am afterward, Monday, the S&P fell and was down 0.6% to 1646 (rounded) at the close.

VIX was up only 5% to 15.10.  At 15.1, VIX is implying a move of about 4% over the next 30-day period.  Theoretically, that move could be up or down.  Currently, I’d say the risk is down, but the low value of VIX still indicates the Options players are not yet in correction mode.

The S&P 500 closed at the 50-dMA Friday and today it fell further.   No bounce today; indeed, there was accelerated selling in the last hour when the pros are in action.

The 10-day moving average of stocks advancing on the NYSE fell to 36% at the close.  Usually a value below 50% signals additional trouble for the markets.   For the day only 19% of stocks advanced. 

New-lows of 459 outpaced the new-highs of 16 today leaving the spread at -443 with the 10-day change in spread trending down.

Today’s reading of Internals is negative on the market and suggests the market is likely to continue its downward trend, although a bounce is possible at any time. 

Monday, the overall NTSM analysis was HOLD at the close.

There have been only 7-Up days in the last 20-trading days.  Some may see that as a buying opportunity tomorrow – I don’t.

I remain about 20% invested in stocks as of 5 March (S&P 500 -1540).  The NTSM system sold at 1575 on 16 April.  (This is just another reminder that I should follow the NTSM analysis and not act emotionally – I am under-performing my own system by about 2%!) 

I have no problems leaving 20% or 30% invested.  If the market is cut in half (worst case) I’d only lose 10%-15% of my investments.  It also hedges the bet if I am wrong since I will have some invested if the market goes up.  No system is perfect.