By: SAM RO
For as long as we’ve had a stock market, we’ve had the risk that it would crash.
In recent weeks, however, stocks have continued to roar to new all-time highs, far outpacing expectations for earnings growth.
As such, valuations have become frothy, and many signals are telling us that the market is being dominated by complacency and euphoria.
Because we may be in a bubble, the bears warn that we could see the stock market actually accelerate before we experience a violent crash.
“I still see end Q4 2013, through to end Q1 2014, as the window in which we see a significant risk-on top before giving way, over the last three quarters of 2014 and through 2015, to what could be a 25% to 50% sell-off in global stock markets,” warned Nomura’s Bob Janjuah in a recent note to clients.
What follows is a compilation of the warning signs that have been telling experts that the market is irrationally high and set up for a crash.
Citi’s Panic / Euphoria model is closing in on ‘euphoria,’ which means investor complacency is very high.
According to Citi, the model’s components include “NYSE short interest ratio, margin debt, Nasdaq daily volume as % of NYSE volume, a composite average of Investors Intelligence and the American Association of Individual Investors bullishness data, retail money funds, the put/call ratio, CRB futures index, gasoline prices and the ratio of price premiums in puts versus calls.”
Source: Citi, Business Insider
The VIX is down 28% year-to-date. In other words, ‘fear’ has crashed, which is another sign of complacency.
Stocks are expensive relative to 10-year average earnings. This ratio, popularized by Robert Shiller, is above 24, which is much higher than the long-term average of 16.
Record high margin debt has accompanied the rally, meaning investors are increasingly betting with borrowed money.
Earnings growth expectations have only be coming down.
Source: Morgan Stanley
Revenues have been falling short of expectations.
“In terms of revenues, 52% of companies have reported actual sales above estimated sales and 48% have reported actual sales below estimated sales. The percentage of companies beating sales estimates is above the percentage recorded over the last four quarters (48%), but below the average over the previous four years (59%).”
Any strength in revenue has been artificially boosted by acquisitions.
“Year/year revenue growth equaled just 1% in first-half 2013 but surged to 5% in 3Q,” said Goldman Sachs’ David Kostin. “Notably, just 20 companies accounted for 25% of aggregate sales but 50% of growth. 18 of the 20 firms completed acquisitions during the past year. The 20 stocks boosted 3Q sales by 13% versus just 2% for other firms.”
Source: Goldman Sachs, Business Insider
Any strength in earnings per share has been artificially boosted by share buybacks.
Source: Goldman Sachs
Earnings growth has been aided by record high profit margins, which don’t look sustainable.
Trading volumes have been trending lower, suggesting new buyers may be scarce.
RBC Capital Markets
“Volume remains subdued; despite the money flowing into stocks, the public does not yet seem “enamored” – presaging more upside, in our view,” said UBS’s Julian Emanuel.
Source: RBC Capital, UBS
From a profits perspective, the US is far more expensive than the rest of the world.
“This chart shows listed sector profits relative to GDP. U.S. back at prior peaks. A V-shaped profit recovery, despite a lackluster GDP recovery. Elsewhere, profits only recouped half their Great Recession losses, and have been falling (as a share of GDP) since. Bottom line: there’s less upside in U.S. profits, more upside elsewhere. And combine America’s stretched equity valuations on sky-high earnings, versus below-record earnings and cheaper valuations elsewhere — and I’d rather not be in U.S. equities.”
Source: Gerard Minack, Business Insider
Relative to GDP, the U.S. stock market looks very expensive.
“Measured by market capitalization as a percent of GDP, Eastern Europe and smaller euro zone peripheral countries now appear to be the most undervalued of major regions worldwide. Major peripheral countries in the euro zone (Greece, Ireland, Italy, Portugal, and Spain) are also below their average level of market cap to GDP over the past 10 years, indicating further room for equity returns, compared to other developed markets.”