Professional Documents
Culture Documents
Why This Time Could Be Different
Why This Time Could Be Different
Fundamentally Speaking
Valuations
As I stated yesterday, earnings growth is deteriorating, and valuation expansion has ceased. As I
addressed in "Shiller's CAPE - Is There A Better Measure:"
"The need to smooth earnings volatility is necessary to get a better understanding of what the
underlying trend of valuations actually is. For investor's periods of 'valuation expansion' are
where the bulk of the gains in the financial markets have been made over the last 114 years.
History shows, that during periods of 'valuation compression' returns are much more
muted and volatile.
Page 1, 2015 Advisor Perspectives, Inc. All rights reserved.
"There is a high correlation between the movements of the CAPE-5 and the S&P 500 index.
However, you will notice that prior to 1950 the movements of valuations were more coincident
with the overall index as price movement was a primary driver of the valuation metric. As
earnings growth began to advance much more quickly post-1950, price movement became
less of a dominating factor. Therefore, you can see that the CAPE-5 ratio began to lead overall
price changes.
As I stated in yesterday's missive, a key 'warning' for investors, since 1950, has been a
decline in the CAPE-5 ratio which has tended to lead price declines in the overall
market."
Economic Growth
Just recently the Congressional Budget Office (CBO) downwardly revised their always over-inflated
economic forecast. (As an aside, this is the same organization that has never gotten any of their
forecasts correct. In 2000, they projected a $1 Trillion budget surplus in 2010 versus a $1 Trillion
Page 2, 2015 Advisor Perspectives, Inc. All rights reserved.
In a strongly growing economy, that would support sustained earnings growth and higher valuations,
expectations of rising inflation would be found. There is historically a strong link between inflation
expectations and the S&P 500. That was until the start of QE-3 in December of 2012 which flooded
the financial markets with liquidity sending asset prices surging without a subsequent pickup in
economic growth.
As shown in the chart below, the decline in inflation expectations suggests that the economy is running
at a far slower pace than headline statistics suggest. As a consequence, the detachment of the
financial markets from economic realities leaves investors at risk of a more substantial
correction.
Technically Speaking
From a technical viewpoint, the markets are currently behaving in a manner that has been more closely
associated with the beginning of previous bear market declines.
The chart below shows only two moving averages of the S&P 500 index. The short term two-week
moving average is in blue as opposed to the one-year moving average in red. Historically, when these
two moving averages have crossed it has been representative of a more severe market correction or
bear market. This is with the exception of the 2011 correction which was halted by the
intervention of the Federal Reserve's second round of quantitative easing.
Page 4, 2015 Advisor Perspectives, Inc. All rights reserved.
While the moving averages have not crossed as of yet, there WILL do so in the next few days. Very
likely, the only thing that would stop a bigger correction from that point would be the onset of another
Federal Reserve intervention.
Momentum
As I discussed previously in "Think Like A Bear, Invest Like A Bull:"
"The effect of momentum is arguably one of the most pervasive forces in the financial markets.
Throughout history, there are episodes where markets rise, or fall, further and faster than logic
would dictate. However, this is the effect of the psychological, or behavioral, forces at work as
"greed" and "fear" overtake logical analysis."
Currently, momentum has clearly broken in the market as shown below. The break in momentum has
not only been a good signal to reduce equity risk exposure during bull markets, but also a warning
signal of impeding bear markets.
Page 5, 2015 Advisor Perspectives, Inc. All rights reserved.
Notice in the chart that margin debt reductions begins innocently enough before accelerating
sharply to the downside."
No one knows for sure where how far the market needs to fall before "margin calls" are triggered.
However, if that point is eventually reached, there will be very little investors can do to shield
themselves from the decline.
Yes, if you become more conservative now, you might just miss some of the recovery if the market can
regain its bullish stance. Of course, it is relatively easy to re-enter the markets when the picture
become clearer. However, those that refuse to accept the notion that it is possible the bull market just
ended will once again see irreparable damage done to their retirement savings once again.
While it is correct that given enough "time" the markets will eventually recover previous losses, the
"time" lost to save, invest and grow funds to meet your retirement goals will not.
Just something to think about.
Lance Roberts
Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host
of "Street Talk with Lance Roberts", Chief Editor of "The X-Factor" Investment Newsletter and the Streettalklive daily
blog.
Streettalk Live