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The Healthy Bull Market: Bah, Humbug!

December 2, 2014

Are you a long-term investor? Convinced that all you have to do is wait long enough to be guaranteed huge stock market profits?

Take a look at the chart below of rolling 30-year returns of the S&P 500 and tell me if it affects your enthusiasm.

The reality is that stock market results vary widely depending on what your starting point is. For example, any investor who put $100,000 into the stock market 1954 was rewarded with roughly the same $100,000 30 years later in 1984.

Yup… 30 years in, and not a penny of profits.

With the stock market at all-time highs, you may find it hard to be pessimistic, but the stock market is doing as well as it’s ever done, with a rolling 30-year return of better than 400%.

How would you feel about earning 0% on your money for 30 years?

Could the stock market go even higher? Yes, it could—but the odds aren’t favorable after the QE-fueled rally has pushed stocks to historically high valuations.

High valuations? Despite what the mass media and the Wall Street crowd try to tell you, valuations are quite high.

The most popular myth spouted on financial TV these days is the notion that the S&P 500 is trading at 19 times earnings. Baloney!

First, that 19 P/E is based on “forward” earnings, not trailing earnings. As unreliable as economists and self-serving analysts are, I’m surprised that anyone—especially you—believes anything they say.

Second, that forward-looking earnings forecast is based on those 500 companies increasing their earnings by an average of 23% over the next 12 months. Yup… a 23% increase!

That’s extremely optimistic, but I think especially misplaced now that the steroid of quantitative easing is behind us. Consider this: everybody agrees that stocks responded extremely positively to quantitative easing, so doesn’t it make sense to be concerned now that the monetary punch bowl has been yanked away?

The first place to look for signs of waning enthusiasm are small-cap stocks. While the Dow Jones Industrial Average and the S&P 500 were setting all-time highs, the Russell 2000 wasn’t able to punch through its March, July, and September peaks.

This quadruple top looks like a formidable resistance level for small stocks and clear evidence that investors are reducing risk by rotating out of small-cap stocks and into big-cap stocks.

Additionally, financial stocks are showing signs of exhaustion too. Healthy bull markets are often led by financial stocks, but the financials are lagging the major indexes now.

That’s why I think last week’s 3.9% GDP print smelled fishy; some weak economic numbers are spelling trouble.

Durable Goods Orders Not So Good: The headline number for October durable goods orders was strong with a +0.4% increase, but if you back out the volatile transportation sales, the picture is a lot uglier. If you exclude transportation—because just a few $100 million jet orders can skew the numbers—the 0.4% gain turns into a 0.9% decrease.

By the way, orders for defense aircraft were up 45.3%, but orders for non-defense aircraft orders were down 0.1% in October. If not for some big government orders, the results would be absolutely horrible!

Unemployment Claims Rise Despite Holiday Hiring: The job picture, which had been improving, showed some deterioration last week despite going into the busy holiday hiring season. Initial jobless claims jumped to 313,000, a 7.2% increase from last week as well as much higher than the 286,000 forecast. It also broke a 10-week streak of claims below 300,000.

Before You Cheer Cheap Oil: After OPEC agreed to keep production levels unchanged, the price of oil plunged by 7% on Friday to less than $68 a barrel. That’s good news for drivers, but oil’s falling prices (as well as those of other commodities) are a very bad sign for economic growth. Moreover, the energy industry has been one of the few industries producing good, high-paying jobs. Thus, low oil prices could turn that smile into a frown in no time.

The Bond Conundrum: The yield on 10-year Treasury bonds was as high as 3% earlier this year but dropped to 2.31 last Friday. If our economy were rocking as well as the 3.9% GDP rate suggests, interest rates should be rising… not falling like a rock.

The stock market may not fall out of bed tomorrow morning, but the holiday season for stock market investors looks like it may be more Scrooge than Santa Claus.

Tony Sagami
Tony Sagami

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