Seven Reasons the Bear Market Has Just Begun
On March 10th 2009 the US stock market hit an intraday low and put in the now-famous "Haines bottom"--coined after my friend, the late great Mark Haines, who made one of the most prescient calls in market history. It should be noted by the time that fateful day arrived it was virtually impossible to find a single bull out of all the geniuses on Wall Street.
Since then the major indexes have more than doubled. Therefore, today the narrow-minded canyons of Wall Street are littered almost entirely of trend following bulls and cheerleaders that don't realize how little there is to actually cheer about. Stocks values are far less attractive than they were on that day back in 2009 and this selloff has a lot longer to run. There are hordes of perma-bulls calling for a "V" shaped recovery in stocks, even after multiple years of nary a down tick. But the following are seven reasons why I believe the bear market in the major averages has only just begun:
Stocks that were hated in 2009 are now unconditionally loved. This is clearly evidenced by margin debt which recently reached an all-time high. According to the National Inflation Association, margin debt recently jumped over $30 billion, or 6.5% to $507 billion, which was equal to a record 2.87% of U.S. GDP. This surpassed the previous all-time high of 2.78% set in March 2000--the top of the largest stock market bubble in world history. And despite the assurance of many fund managers that investors have boat loads of cash ready to deploy at these "discounted" prices, cash levels at mutual funds sank to their lowest level of just 3.2% of assets by early August. That's the lowest in history! As a percentage of stock market capitalization, fund cash levels are also nearing the record low set in 2000 when the NASDAQ peaked and subsequently crashed by around 80%.
Stocks are overvalued by almost every metric. One of my favorite metrics is the Price to Sales Ratio, which shows stock prices in relation to its revenue per share and omits the financial engineering associated with borrowing money to buy back shares for the purpose of boosting EPS growth. For the S&P 500 this ratio is currently 1.7, which is far above the mean value of 1.4. The Benchmark Index is also near record high valuations when measured as a percentage of GDP and in relation to the replacement costs of its companies.
There is currently a lack of revenue and earnings growth for S&P 500 companies. According to FACTSET, second quarter earnings shrank 0.7%, while revenues declined by 3.4% from the year ago period. The Q2 revenue contraction marks the first time the Benchmark Index's revenue shrank two quarters in a row since 2009.
Virtually the entire global economy is either in, or teetering on, a recession. In 2009 China stepped further into a huge stimulus cycle that would eventually lead to the largest misallocation of capital in the history of the modern world. Empty cities don't build themselves: they require enormous spurious demand of natural resources, which in turn lead to excess capacity from resource producing countries such as Brazil, Australia, Russia, Canada, et al. Now those economies are in recession because China has become debt disabled and is painfully working down that misallocation of capital. And now Japan and the entire European Union appears poised to follow the same fate.
This is in turn causing the rate of inflation to fall according to the Core PCE index.
And the CRB Index, which is at the panic lows of early 2009, is corroborating the decreasing rate of inflation.
But the bulls on Wall Street would have you believe the cratering price of oil is a good thing because the "gas tax cut" will drive consumer spending--never mind the fact that energy prices are crashing due to crumbling global demand. Nevertheless, there will be no such boost to consumer spending from lower oil prices because consumers are being hurt by a lack of real income growth, huge healthcare spending increases and soaring shelter costs.
US manufacturing and GDP is headed south. The Dallas Fed's Manufacturing Report showed its general activity index fell to -15.8 in August, from an already weak -4.6 reading in July. The oil fracking industry had been one of the sole bright spots for the US economy since the Great Recession and has been the lead impetus of job creation. However, many Wall Street charlatans contend the United States is immune from deflation and a global slowdown and remain blindly optimistic about a strong second half.
Unfortunately we are already two thirds of the way into the third quarter and the Atlanta Fed is predicting GDP will grow at an unimpressive rate of 1.3%. Furthermore, the August ISM manufacturing index fell to 51.1, from 52.7, its weakest read in over two years. And while Gross Domestic Product in the second quarter came at a 3.7 percent annual rate, due in large part to a huge inventory build, Gross Domestic Income increased at an annual rate of only 0.6 percent.
GDP tracks all expenditures on final goods and services produced in the United States and GDI tracks all income received by those who produced that output. These two metrics should be equal because every dollar spent on a good or service flows as income to a household, a firm, or the government. The two numbers will at times differ in practice due to measurement errors. However this is a fairly large measurement error and it leads one to wonder if that 0.6% GDI number should get a bit more attention.
Global trade is currently in freefall. Reuters reported that exports from South Korea dropped nearly 15% in August from a year earlier, with shipments to China, the United States and Europe all weaker. US exports of goods and general merchandise is at its lowest level since September of 2011. The latest measurement of $370 billion is down from $408 billion, or -9.46% from Q4 2014. And CNBC reported this week that the volume of exports from the Port of Long Beach to China dropped by 10% YOY. The metastasizing global slowdown will only continue to exacerbate the plummeting value of US trade.
The Fed is promising to longer support the stock market. Back in 2009 our central bank was willing to provide all the wind for the market's sail. And despite a lack luster 2% average annual GDP print since 2010, the stock market doubled in value on the back of zero interest rates and the Federal Reserve's $3.7 trillion money printing spree. Thus, for the past several years there has been a huge disparity building between economic fundamentals and the value of stocks.
But now the end of all monetary accommodations may soon occur while markets have become massively over-leveraged and overvalued. The end of QE and ZIRP will also coincide with slowing US and global GDP, falling inflation and negative earnings growth. And the Fed will be raising rates and putting more upward pressure on the US dollar while the manufacturing and export sectors are already rolling over.
I am glad Ms. Yellen and co. appear to have finally assented to removing the safety net from underneath the stock market. Nevertheless, Wall Street may soon learn the baneful lesson that the artificial supports of QE and ZIRP were the only things preventing the unfolding of the greatest bear market in history.