Monday, September 23, 2013

Corporate Profits Suggest Problems for the Stock Market

We have seen from a number of analysts that US profits are at all-time highs (Hussman, et al.).  

“From the standpoint of long term stock market returns, the most important feature of valuations to note at present is the extreme level of profit margins, which are more than 70% higher than historical norms. This is well-explained by the fact that the deficits of one sector must, in equilibrium, emerge as the surplus of another sector…Though the actual course of corporate profits will be affected by numerous factors, including the extent to which extraordinary fiscal deficits normalize, we would expect corporate profits over the coming 3-4 year period to contract at a rate of somewhere between 5-15% annually.” – John Hussman, PhD, Weekly market Comment for 23 September 2013. Commentary at…

We also have more companies suggesting that forward profits are expected to fall.  (See latest FACTSET Earnings Insight, excerpted below.).

FACTSET EARNINGS INSIGHT, September 20, 2013 (Factset)
“At this point in time, 107 companies in the index have issued EPS guidance for the third quarter. Of these 107 companies, 88 have issued negative EPS guidance and 19 have issued positive EPS guidance. As a result, 82% (88 out of 107) of the companies that have issued EPS guidance for the third quarter have issued negative EPS guidance. This percentage is consistent with the percentage recorded in the previous quarter at this time (81%), but well above the 5-year average of 62%.”  Excerpted from the FACSET Earnings Insight report for 20 Sep 2013. 

Now the market is considering whether the FED continuation of QE is good news or Bad news

“The euphoria with which investors in the U.S. stock market greeted the Federal Reserve's decision to stick with its easy-money policy has begun to evaporate, as the message the Fed was sending about a less-than-stellar economy sinks in.  An economy still in need of a safety net may be too weak to produce robust earnings growth, meaning that the Standard & Poor's 500 valuation, now at its most expensive on a price-to-earnings basis since 2010, becomes harder to justify.”  Story at…

My guess is that smart-money agrees with the above Reuters piece: it is bad-news, for the short term anyway.  That guess is based on two issues: (1) late-day-selling that has been down over the last 5,10, and 40-day periods; (2) the high volume on the down Friday.  The market didn’t change all that much for the huge amount of shares traded.  Friday looked like the smart-money sold the “bag” and now the new buyers are left holding it.  I still think the market needs to re-test 1573 or may trade down to the 200-day moving average, now at 1584. The wild card is the FED. Can the FED keep the markets propped up if earnings do deteriorate as predicted?  I doubt it.

I remain in the minority with that opinion.

Here’s the opposing comment from a trader board: “Since nothing has changed QE wise, I'm thinking the same pattern of buy the dip is in full effect.  Those dips have not been allowed to happen more than 3 to 5 day in a row…”  Apparently that opinion is wide spread; my sentiment indicator was 65% bulls at Friday’s close based on dollars bet long or short in selected Guggenheim/Rydex funds.

Monday, the S&P finished down 0.47% to 1702 (rounded) at the close.
VIX rose 9% to 14.31 so the options boys woke up.

The 10-day moving average of stocks advancing on the NYSE fell from 58% to 54% at the close.  (A number above 50% for the 10-day average is generally good news for the market.) 

New-highs outpaced new-lows today, Monday, leaving the spread (new-hi minus new-low) at +44 (it was +129 Friday), but the 10-day moving average of change in the spread is now minus 85. 

The Internals are neutral to negative on the market in the short term.

Monday, the overall long-term NTSM analysis remains HOLD at the close.

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.