The Turtle and the Pendulum
Change is the sum of fundamental trends, the gradual elimination of accumulated extremes, and the random arrival of new shocks. This is true for nearly every process, including economic growth and stock market returns.
Subsets and Sensibility
One of most dangerous habits of a speculative crowd is the tendency to use unconditional averages and unconditional probabilities regardless of how extreme market conditions have become. This is like stepping into a house with two rooms, one with the temperature at 0 degrees and one at 140 degrees, and expecting a temperature of 70 either way.
Asking a Better Question
It's the wrong question to ask, "How can we somehow force internals to look like trend-following measures that aren't as reliable across history?" Happily, abandoning that question frees us to ask a better question. Once one accepts that internals are, in fact, behaving as intended, the question becomes: "How can we benefit during bearish conditions when valuations and internals validly hold us to a defensive outlook, yet obvious but less reliable trend-following measures remain favorable?" As John Dewey wrote, a problem well-stated is half-solved.
Fed Pivots and Baby Aspirin
The key takeaway is that attending directly to market internals is actually more effective than attending to monetary easing or tightening. Still, given that we can expect a pivot toward lower rates in the near future, how much do valuations tend to increase, on average, in the 3, 6, 12, and 24 months following a Fed pivot? The answer is simple. They don’t.
Going All In – The Bubble in Profit Expectations
The heady optimism in forecasted earnings is hiding in aggressive expectations for profit margins. The rise in market valuations has been much more tightly linked to those elevated margins - and expectations for even higher margins next year and the year after - than investors may realize. If the widely held belief that public companies will perpetually become more profitable begins to falter, the steep valuation premium that has been priced into U.S. large-cap stocks over the past decade may evaporate.
You’re Soaking in It
There’s a very rare set of market conditions extreme enough to deserve a ‘warning.’ As Madge said in the old Palmolive dish soap commercials, ‘you’re soaking in it.’
You Can Ring My Bell
I may as well just say it. Based on the present combination of extreme valuations, unfavorable and deteriorating market internals, and a rare preponderance of warning syndromes in weekly and now daily data, my impression is that the speculative market advance since 2009 ended last week. Barring a wholesale shift in the quality of market internals, which are quickly going the wrong way, any further highs from these levels are likely to be minimal. In contrast, current valuation extremes imply potential downside risk for the S&P 500 on the order of 50-70% over the completion of this cycle.
Skating By The Trap Door (Motherlode II)
There are certain features of valuation, investor psychology, and price behavior that tend to emerge when the fear of missing out becomes particularly extreme and the focus of speculation becomes particularly narrow. On Friday, May 24, we hit a fresh “motherlode” of these conditions.
This Is Where You Start Bear Markets From
Statistically, the current set of market conditions looks more “like” a major bull market peak than any point in the past 75 years, and I suspect, any point other than the 1929 peak. As Jeremy Grantham recently observed, "This is where you start bear markets from."
Universal Capitulation and No Margin of Safety
The stock market presently stands at valuation extremes matched only twice in U.S. financial history: the week ended December 31, 2021, and the week ended August 26, 1929. Meanwhile, despite all the bluster about technological improvements driving durable increases in corporate profitability over time, the fact is that corporate profit margins before interest and taxes have hovered around the same level for 75 years.