The following chart from the St Louis Fed indicates that Corporate Profits are at an all time high relative to GDP. This is an anomaly that can’t last and shows an absolute tendency for mean reversion.
John Hussman approaches this as an economist and says that high
corporate profits are the direct result of low savings by households (debt) and
the Government (deficits)….[Regarding
the implications for the stock market]…”We can demonstrate in a century of
evidence that…profit margins are mean-reverting and inversely related to
subsequent earnings growth…John Hussman, PhD, Weekly Market Commentary for 25
November 2013 from Hussman Funds at...
http://www.hussmanfunds.com/
John Hussman’s
analysis contained in his 25 November 2013 Weekly Market Commentary, “An Open
Letter to the FOMC” notes that Corporate Profits as a percentage of GDP are at
an all-time high and must revert to the mean.
A reversion to the mean predicts corporate earnings will decline.
This naturally
raises the question, “How have declines in this statistic affected the stock
market in the past?” Surprisingly, the
answer isn’t as clear as I expected.
Here is a chart of the S&P 500 and Corporate Profits (as a percent
of GDP) from 1964 through April 2013 (most recent data from FRED).
Most recently,
during the dot.com era profits were falling from 1997 to 2000, but the S&P
500 advanced dramatically. We can discount
the dot.com era, because investors were sure that “profits-didn’t-matter”. (The Fed burst the dot.com bubble with
repeated rate hikes starting about 6-months before the top.)
Another case
where profits fell while the S&P advanced was from 1978 thru 1985. During that period, profits as a %-of GDP
were cut by more than half while the S&P 500 more than doubled. That was during the late-stages of the 1966-1982
bear market and the beginning of the secular bull that lasted from 1982 until
the dot.com bust in 2000. I plotted
another chart (below) focusing on the 1966-1985 period.
The Cyclically
adjusted PE (PE10) was near all-time lows in the late 70’s (it had only been
lower in the 1920’s and 1930’s) and it encompasses the end of the 1966-1982
bear and the beginning of the 1982-2000 Bull market. One can surmise that investors anticipated
improving economic conditions and, with stock prices at generational lows,
began bidding up stock prices in the late 70’s.
This has little in common with current conditions since PE’s based on
operating earnings are above average (per FactSet) and the PE10 is now
significantly elevated (Hussman et al). Valuations are now at levels associated
with the beginning of a bear market rather than its end (dShort.com).
Another point to
remember: the “profit” considered in this analysis is “Profit as a percent of
GDP”. If GDP is rising, the “profit as a
percent of GDP” number will be falling unless corporate profits are rising at the
same or a faster rate than GDP.
To conclude,
falling profits as a percent of GDP have generally been a significant issue for
the markets, but the lag time (or lead time) has sometimes been years. My point is simply that if profits start
falling now, the market could continue its advance for some time – possibly as
long as the Fed continues to prop it up. – Meade Stith
CONSUMER CONFIDENCE IN US DECLINES TO 7-MONTH LOW (Bloomberg)
“The Conference Board’s index fell to 70.4 from
a revised 72.4 a month earlier that was stronger than initially estimated, the
New York-based private research group said today…’The economy just has not
performed very well this year and has been disappointing relative to what most
people were hoping for and expecting through the course of the year,’ said Stephen Stanley, chief economist at Pierpont Securities LLC
inStamford, Connecticut.”http://www.bloomberg.com/news/2013-11-26/consumer-confidence-index-in-u-s-decreased-to-70-4-in-november.html
MORE ON CONSUMER CONFIDENCE
For details, analysis and charts regarding the decline in consumer
confidence see Advisor perspectives at…http://advisorperspectives.com/dshort/updates/Conference-Board-Consumer-Confidence-Index.php
MARKET REPORT
Tuesday, the S&P was up for most of the day, but finished unchanged at 1803 (rounded) on surprisingly high volume (15% above the norm for the month). I guess all of the traders sold positions late in the day and left town for the holiday.
VIX was up 0.2%
to 12.81.Tuesday, the S&P was up for most of the day, but finished unchanged at 1803 (rounded) on surprisingly high volume (15% above the norm for the month). I guess all of the traders sold positions late in the day and left town for the holiday.
MARKET INTERNALS (NYSE DATA)
The 10-day moving average of stocks advancing rose to 54%
at the close Tuesday. (A number above 50%
for the 10-day average is generally good news for the market.) New-highs outpaced new-lows Tuesday, leaving the spread (new-hi minus new-low) at +179 (it was +176 Monday). The 10-day moving average of change in the spread was plus 3. In other words over the last 10-days, on average, the spread has increased by 3 each day.
Advancing volume is trending down, so this trend
following indicator is neutral on the market in the short term.
Market Internals are a decent trend-following analysis of current market action, but in 2013 (so far), if I had been buying the positive ratings and selling negative ratings I would have under-performed a buy-and-hold strategy.
NTSM ANALYSIS
Sentiment is EXTREME
negative ( Should I say absurd extreme?) at 76%-bulls for the 5-day indicator
for the third day ion a row. (Three out
of four investors in Rydex/Guggenheim funds I track are betting long.) Overall, NTSM is neutral. (I am mostly out of the market already.)
MY INVESTED POSITION (NO CHANGE)
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.
I still lean toward getting back in, after a pullback, to
speculate on a final ride to the top.
NTSM did give several buy signals over the weeks of 14 and 21 Oct, but
the market just looks too frothy to rush back in…we’ll see if the market will
pullback so I can join the insanity. If
not, cash is fine.
