Rationales & Targets
We were reminded a few days ago by our friend and savvy trader, Grant Nobel, that the Russell 2000 Index was about as overvalued as one might imagine, trading at infinity times earnings. It’s bad enough to see the broad S&P 500 at a P/E over 26 and the Dow Industrials at a 21.4 P/E, but a 2000 stock index that shows negative earnings?! Good grief. One would think an index of 2000 small caps just generate something, anything in earnings. Even a year ago, the Russell 2000 were trading over 152 times earnings. Despite the obvious, that a few rotten apples have likely sabotaged the tally, it’s just another example of the lack of value in U.S. stocks. There’s more, too. The S&P Industrials are nearly 30 times earnings and those earnings have fallen 12.6% in the past year. S&P 500 earnings have declined 8.4%. And the earnings for the 30 venerable stocks in the Dow Industrials have shed 13.2%. And a mania is underway. We certainly live in interesting times.
Turns out the equity mutual fund cash-to-assets ratio was restated for October and had fallen to 3.1%, a brand new record low. Mutuals need to shrink cash to compete with ETFs, right? Stock pickers not required, just buy the nifty fifty of the current era. And this is happening with margni debt less than a billion dollars from another record high. There’s too much evidence of risk taking on a humongous scale to be anything but negative on prospects. Watchwords for 2017: terror and cyber strikes.
Net Liquidity Still Horrid
Combined margin debt for the NYSE and NASD in November came in only 0.1% lower than the $540.6 billon record set in September. Given roughly 2% gains in the broad S&P 500 in the past month, we are likely looking at another brand new record. Our net liquidity indicator (not shown) bottomed in October at minus $267 billion and was slightly better in November at $258 billion. Again, given the circumstances, we’d bet on a new record liquidity low when the results are released for December (usually the last week of each month).
Are Corporate Treasuries the Only Buyers of Stocks?
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ETFs are not anywhere near the size of equity mutual funds and despite net inflows into ETFs, they do not counter the continuing enormous outflow from mutual funds. At left below, we have combined the flows for domestic ETFs and mutual funds for the last two years. Despite sizable inflows into ETFs, the historic exit from mutual funds continues to skew the result, which shows $88.7 billion in outflows. At bottom right, our ten-week measure of cumulative inflows for domestic mutual funds has now ratcheted down to quite near the lows of late 2011. The correction that accompanied the long slide in inflows mid-2011 was close to 2000 Dow points and 16%. We have shown similar charts over the couple of years and they all point to the baffling circumstance of prices continuing on the upside as money flows out of stocks.
At this point, can there be any doubt that corporate treasuries are by far, the largest source of demand for stocks? More importantly, we believe buybacks are now threatening the very same companies that continue buying their own grossly inflated and overvalued share. Typically in the past, buybacks were undertaken by companies that have cited their shares as undervalued. In fact, we’ve seen that strategy when the stock market has taken a huge hit, such as the Crash of ‘87. A report by F.H. Buckley, written for the Indiana Law Journal in 1990 (see http://bit.ly/2iKhdPF) correctly claims, “There were a particularly large number of buyback announcements in the period immediately following the 1987 stock market crash, and they have been credited as a major factor arresting stock price declines at that time.”
However, all current valuation measures that we’ve seen strongly imply precisely the opposite. Rather than arrest any downside, they have only served to inflate prices and thus, valuations to extremes seen at key reversal points in the past. Andrew Smithers latest report on valuations (see http://bit.ly/2idcchQ) claims “non-financials” were overvalued by 56% at the end of June and 61% at the end of September. Buybacks at current levels are the stuff of insanity.
For more information, please contact us:
Alan M. Newman, Editor, Crosscurrents
516-557-7171
www.cross-currents.net
