September 2018 - Bubbles and Bottoms for Stock Markets -

Another month, another all-time high. At least for the U.S.! Strangely the U.S. stock markets are diverging from the rest of the world, and it now accounts for 120% of the year-to-date move on the MSCI index (stock market index with companies from around the world). Comparing this to the year-to-date contribution from other countries, and you`ll see the massive divergence that`s taking place.

Checking out the forward-looking price-to-earnings ratio, you get to see that since early 2016 there has been a wider and wider gap between the S&P 500 index and the MSCI index minus the US. Reversion to the mean will surely take place at some point, but the question is when? And will the MSCI index meet the S&P 500 index to the upside, or will the S&P 500 index meet the MSCI index to the downside?

Strangely enough, this divergence takes place at a time when the FED (Federal Reserve) is already tightening (increasing interest rates and tightening fiscal stimulus) while the ECB (European Central Bank) and BOJ (Bank of Japan) are still lenient in their fiscal policies. But more on that in the next chapter.

According to many different types of economic models, U.S. stocks areovervalued and in proper bubble territory.
Profit margins are at a record high for S&P 500 companies, now above 12%, while the long-term average is just slightly above 8%. Corporate profits have also reached record levels, but as a percentage of GDP, as shown below, it has levelled off since 2015. More about this later.

The manufacturing index is almost at the high levels that were last seen during the early 80`s.

The ever-increasing profit margins have resulted in an S&P 500 index that has seen a record number of days above its 200-day average level, currently being above that level for a record 570 days. I have said this a few times now, but reversion to the mean WILL happen, it`s just a matter of when.

Goldman Sachs` bull/bear indicator, which combines the average percentile for ISM (manufacturing index), slope of the yield curve, core inflation, unemployment and the Shiller P/E ratio, has been a great indicator for recessions, and has practically predicted every single recession in the past 7 decades. The indicator is now reaching levels that are surpassing the 2000 and 2007 peaks, and goes way back to levels that were last seen in the early 70`s.

Going back to the earlier mentioned Shiller P/E ratio; this is one of my favourite ratios that smoothes out the average S&P 500 price to earnings ratio by taking the average inflation adjusted earnings from the previous 10 years, and thus giving a better view of cyclically adjusted P/E levels.
To make this ratio even more effective, John Hussman decided to take it one step further, and introduced the “margin adjusted Shiller P/E ratio”, which is basically the Shiller P/E ratio normalized for variation in corporate profits as a percentage of GDP. In the past two months i`ve shown you corporate debt as a percentage of GDP, as well as stock market cap as a percentage of GDP, and below you can find the final comparison between corporations and GDP: corporate profit margin as a percentage of GDP.

Last month I told you in depth about the Hindenburg Omen and the effectiveness of the indicator. Basically, the more times it is “triggered”, the higher the likelihood of a stock market decline becomes. Below is an updated version of last month`s chart. Over the past 4 weeks, 20 Hindenburg Omens have been triggered, the largest number in over 40 years.

"Get out when you can, not when you have to."
- Jesse Livermore -

The final chart that I want to show you is a macro model from Crescat Capital, which basically combines 17 indicators, most of which i`ve shown to you over the past 3 months, and gives all of these indicators a percentile score. As you can see, the average of these indicators is currently at its highest historical percentile ever, even higher than the 2007 and 2000 peaks. This chart speaks a thousand words.

The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.