June 26, 2016 (11:47 am)
- S&P 500: 2037.41 (6/24/16 close)
- 200dma: 2020.80
- 50dma: 2079.86
- Price/200dma: 101%
- 200dgr: -2.46%
In the words of Kenny Smith and Vince Carter in the 2000 NBA Slam Dunk Contest, “It’s over.” This extraordinarily overvalued, over-owned, and overly complacent market was in search for a downside catalyst…and it found one, courtesy of “Brexit”.
Jeremy Grantham thought that the Fed would induce one last push toward a “2-standard deviation overvaluation” level of 2250, or higher. I believe we got ‘that’ coming out of the February bottom with the Fed falling all over itself to halt its tightening program…but IMO, now it’s over.
In reality, the mechanics of Brexit should not materially impact the long-term fair value of global equity markets, if at all. And even the extrapolation of political unrest extending to the rest of Europe pales in comparison, IMO, to the significance of the threat of the sewer that is the European banking system imploding back in 2011/2012. As such, focus on the legality and enforceability of Brexit (which the ‘bull’ camp has been quick to do this weekend) misses the point of its significance as it relates to broad market risk/reward.
As stated: investors are quite literally ‘all-in’ + highly complacent, and broad market valuation is extremely elevated. But most importantly, on top of this dangerous set of conditions (for bulls) is the fact that global central banks are – again, quite literally – ‘all-in’. The ECB is buying everything but equities; the BOJ is buying equities; and the Federal Reserve is as ‘easy’ as it can credibly be at this juncture. The only possible central bank catalyst is the Fed restarting its QE program…but that likely will not happen with the S&P 500 – Yellen & Co’s favorite financial conditions gauge – above 1800.
As discussed in late April, this market is revolting against the overvaluation produced by global central banks. Valuation is financial market gravity – and with market conditions in near-perfect position for a downside move + Brexit acting as a powerful downside catalyst, I believe the stage is set for a material decline over the coming months and quarters.
But why now, after one day of declines?
The global market response to Brexit was not simply a ‘healthy’ correction within an on-going bull market. Over 90% of NYSE volume was on the downside; and total volume was 96% higher than the day before. With 40% of stocks at least 20% below their 52-week high, supply rising, and market sentiment breaking down…this is not healthy market action.
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Before some brief analysis, I want to highlight an indicator I discussed in a late March write-up: the S&P 500’s 200-day moving average “200-day growth rate” (200dgr). That is, the current 200dma versus the 200dma 200 days ago. Sounds silly, but…
Since 1991, the 200dma has fallen more than 1% only twice: the 2000-2002 and 2007-2009 bear markets. Currently, the 200dma is falling by more than 2% 200 days over 200 days.
Market bottoms occur with this indicator deeply negative…but those bottoms typically occur with extremely depressed market sentiment, attractive valuations, and an exhaustion of supply. Market sentiment was very depressed at the early February low; but valuation remained far from attractive levels, and supply continued to rise.
S&P 500 Median Price to Sales
Net % Say Equities & Bonds Overvalued
While the S&P 500’s median PSR is at all-time highs, the most critical factor is the fact that market participants know and believe that valuations are at or near record highs. Interestingly, it pays to do as market participants say, not as they do.
In a recent Hotline write-up, Ned Davis (himself) said the following about market valuations:
“A client asked me if I had ever seen so many valuation indicators all showing this kind of overvaluation at the same time, and I answered, ‘Only in 1929, 2000, and 2007.'”
US Stocks Above 200dma
ACWI Stocks Above 200dma
SPX Stocks With 50dma>200dma
The configuration of all three ‘breadth’ indicators is ‘technically’ bullish. But I believe deceivingly so; and interestingly, all three sit directly on the levels I deemed ‘stop loss’ levels for my bearish market stance.
The early 2002 bear market rally saw the above indicators reach current levels…just prior to plunging to final bear market lows. And given the market’s overvaluation, investor positioning, and the trend in selling pressure…I believe the Brexit catalyst just initiated a similar decline.
Hardcore market ‘bears’ will argue that we are closer to the beginning than the end of this on-going bear market – perhaps we are. But I believe the fact that the % of stocks in bear markets reached just over 70% in February indicates we are closer to the end than the beginning. The end likely arrives with a ‘lower high’ in supply, and the % of stocks in bear markets over 90%.
AAII Equity Allocation
Very simply – investors are fully invested and highly complacent.
Barron’s article on the underlying strength of the market in the face of the Brexit downside catalyst is precisely what you want to see if bearishly positioned. If the market was racing to justify getting out of the market, that would tell us folks are defensively positioned…