Divergences Continue to Send Warning Signals

The chart formation built in the course of the early February sell-off and subsequent rebound continues to look ominous, so we are closely watching the proceedings. There are now numerous new divergences in place that clearly represent a major warning signal for the stock market. For example, here is a chart comparing the SPX to the NDX (Nasdaq 100 Index) and the broad-based NYA (NYSE Composite Index).

 

The tech sector is always the last one to get the memo – we have dubbed this the “flight to fantasy” – and it is always seen near major market peaks. Incidentally, the Nasdaq was the last index to peak in 1987 as well (the DJIA topped out in late August of that year, the Nasdaq on October 5). So this is a well-worn tradition. The divergences that have been established between these indexes in the recent rebound from the early February are a big red flag in our opinion.

 

The Urge to Burn Money

As mentioned in the annotations on the chart above, investors are now paying 10 times revenues for more stocks than at any time since early 2000. We discovered the following gem via Jesse Felder’s latest report (well worth reading in its entirety). A few years after the peak of the tech mania, former Sun Microsystems CEO Scott McNealy was interviewed by Bloomberg. He said the following about Sun’s peak valuation in 2000 (it was one of the stocks trading at more than ten times sales at the time):

 

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

 

(emphasis added)

The answer is of course that nobody did much thinking at the time – and the same is evident recently as well. Also via Mr. Felder, here is a chart that shows the number of S&P 500 companies trading at 10 times revenues over time – currently there are 28 such stocks; at the peak of the mania in 2000 there were 36 (for a very brief moment).

 

The number of S&P 500 stocks trading at ten times revenues: “investors” are going crazy again.

 

It is quite ironic that companies trading at such lofty multiples are often characterized by the ability to burn cash at astonishing rates. For example, the above mentioned NFLX  – which is a great company with great subscriber growth rates – reported free cash flows of a negative $2 billion last year and plans to burn through $3 to $4 billion in the current year.

However, to paraphrase Mr. McNealy, what are people who pay ten times revenues for the stock thinking? That there will be some luxury miracle? Hint: there won’t be; investors are going to see their money burn as well, even under the most generous assumptions about the undoubtedly glorious future.

 

Investors Tripping Over Each Other to Get In

Remember when bitcoin exchanges could no longer keep up with all the new customers trying to open accounts? That happened in the two months before BTC peaked – it has since then declined by 55% (and was down by 70% at one point).  Guess what happened in terms of equity fund inflows over the past several months.

 

Inflows into technology equity funds – left hand side, annual flows (in 2018 until March 07 they reached $5 billion, which as far as know is a record for such a short time); right hand side, 8-week rolling flows into tech funds, which shows the recent massive acceleration in inflows in greater detail. They sure love them when they’re expensive. Tech company CEOs are probably happy, since they are selling hand over fist (admittedly, they almost always do – it rarely happens that insiders at these firms do anything else, sincea lot of their compensation comes in the form of stock options).

 

For some reason investors tend to fall in love with tech stocks as soon as they are outrageously expensive. They don’t want to have anything to do with them when they are on sale (which happens rarely enough). The main point is though that whenever investors are getting this impatient to buy something that has gone up in price for many years, it is high time to get out of Dodge, because a financial accident is usually just around the corner. Plot twist: it’s not going to be different this time.

It is also noteworthy that the market rally has become ever more concentrated in a handful of names. There are two reasons for this: 1. diminishing liquidity – it is no longer possible for the tide to lift all boats (this is also the message sent by the divergences in the first chart and by the market’s weak internals) and 2. the popularity of passive investing tends to boost the market caps of stocks that already sport the largest market caps, as new inflows into ETFs are invested according to the weightings of stocks in the underlying indexes. Obviously, this investment technique involves no analysis of the merits of buying these stocks at current levels.

The following chart shows the proportion of the Nasdaq represented by the market cap of just five stocks (the FAANG stocks, i.e., Facebook, Amazon, Apple, Netflix and Google):

 

The combined market cap of the FAANG stocks represents 26% of the total Nasdaq by now. This is traditionally also a major warning sign.

 

Conclusion:

The stock market remains in dangerous waters just as the next rate hike approaches. At such junctures one should keep in mind that it is actually irrelevant whether the economy is doing well, or “forward” earnings estimates are strong, or confidence is high, and so forth. These data points always look great near market tops and conversely look awful near major lows.

The decisive factors for the stock market are liquidity (i.e., money supply growth rates, which have collapsed), valuations (extremely high valuations will eventually be corrected, often violently) and market internals & technical divergences (which are a reflection of liquidity and risk appetites). With respect to the latter, here is an updated chart of the comparison of US and European stocks we frequently show in these pages. The bearish long term divergence between these markets has now been rounded out with a series of bearish short-term divergences:

 

Since the Euro-Stoxx index has never regained its 2015 peak, there are now both long term and short term bearish divergences in place vs. the US stock market.

 

Charts by: StockCharts, Jesse Felder, Thomson-Reuters, BofA Merrill Lynch, Bloomberg.

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Pushing Past the Breaking Point
      Schemes and Shams Man’s willful determination to resist the natural order are in vain.  Still, he pushes onward, always grasping for the big breakthrough. The allure of something for nothing is too enticing to pass up.   From the “displays of disbelief, revealing touching old-fashioned notions” file... [PT]   Systems of elaborate folly have been erected with the most impossible of promises.  That prosperity can be attained without labor.  That benefits...
  • The Myth of Capitalism - A Book by Jonathan Tepper
      Crony Capitalism vs. Free Markets Many of our readers are probably aware of the excellent work our friend Jonathan Tepper does for Variant Perception (VP)*****, a financial research boutique that really does bring a unique perspective to the table*. Jonathan (with co-author Denise Hearn) has just added a new book to his résumé, which is going to be released on 12 November: The Myth of Capitalism (MoC) – Monopolies and the Death of Competition** (a link to the official site is at the...
  • Three Cheers for James Riley!
      Going All In All people, of both good and questionable character, share a singular talent.  They excel at taking something that’s tolerable in moderation, and then pushing it to the outer limits of absurdity.  Why live with restraint when you can get radical?   A fairly famous stretch of LA riverbed graffiti... [PT] Photo credit: saber   Public and private debt levels, NASDAQ stock valuations, the federal register, face tattoos, canned energy drinks.  You name...
  • Crumbling Piles of Sand
      Just a Little Avalanche or an Implosion? A few years ago, we briefly discussed the dynamics of sand piles in these pages, which are a special field of study in mathematics and physics (mathematically inclined readers can take a look at two papers on the subject here:”Driving Sandpiles to Criticality and Beyond “ (PDF) and  'Games on Line Graphs and Sand Piles “(PDF) – unfortunately two other studies that used to be available have in the meantime disappeared from the...
  • When Fake Money Becomes Scarce
      Remaining Focused A rousing display of diversions this week assured the American populace was looking every which way but right under its collective nose.  Midterm elections.  White House spats with purveyors of fake news.  The forced resignation of Attorney General Sessions...   Old drug warrior (otherwise recused) on his way home to Alabama...   Sideshows like these, and many more, offered near limitless opportunities to focus on matters of insignificance.  Why...
  • Fun and Profit - Precious Metals Supply and Demand
      While Not Saving The Planet, Let Us At Least Have A Good Time The price of gold went up seven bucks, and that of silver rose eight pennies. For many people, the attraction to gold and silver began with a desire to protect themselves from the monetary train wreck of 2008. That often grew into a sense that gold is the solution to that problem.   The post 2008 GFC monetary train wreck: US true broad money supply is expanded by more than 153% in a mere decade, as the Fed takes...
  • Wizard’s First Rule – Precious Metals Supply and Demand
      The Last to Go Terry Goodkind wrote an epic fantasy series. The first book in the series is entitled Wizard’s First Rule. We recommend the book highly, if you’re into that sort of thing.   An image from the title page of Terry Goodkind's best-selling fantasy epic “Wizard's First Rule”. We'd be at bit wary of standing around on that stone-slab bridge to be honest. [PT]   However, for purposes of this essay, the important part is the rule...
  • US Stock Market - Re-Coupling with a Panic Cycle?
      The Mighty Gartman Investment newsletter writer Dennis Gartman (a.k.a. “the Commodities King”) has been a target of ridicule at Zerohedge for a long time. His pompous style of writing and his uncanny ability to frequently make perfectly mistimed short term market calls have made him an easy target.* It would be quite ironic if a so far quite good recommendation he made last week were to turn into the call of a lifetime (see ZH: “Gartman: 'We Are Officially Recommending Shorting...
  • Roger Barris for Congress!
      Economic Man Threatens to Leave You Alone if Elected This one is mainly for readers residing in that glorious water source for California commonly known as Colorado. In case you are not aware of it yet, Roger “Economic Man” Barris, an occasional contributor to this site, is running for Congress in Colorado on a Libertarian Party ticket. We will briefly explain why you should vote for Roger, but first two pictures:   Roger Barris, Libertarian Party candidate for the House...
  • It's Not That Day Just Yet - Precious Metals Supply and Demand
      Degrees of Urgency Monday was Veterans Day, a bank holiday in the US. The prices of gold and silver dropped $23 and $0.61 respectively. “But isn’t gold supposed to go up when...?”   Warren Buffet and Aragorn discuss what to do with the gold. Aragorn wants it, because he knows that even if it's not today, “that day” will come. [PT]   Why? Because everyone else will bid it up. Why? Because they expect someone else to bid it up. Why? Warren Buffet is...
  • Revisiting the Halloween Effect
      From Crash Danger to End-of-the-Year Ramp   [Ed note by PT: we are unfortunately a week late in posting this issue of SI, which didn't reach us in time due to a technical problem. We decided to post it belatedly anyway: for one thing, the effect under discussion is normally in effect until the end of the year; for another, the statistical validity of this information goes beyond the current year, as it is a recurring phenomenon. Lastly we would note that we have a strong...

Support Acting Man

Item Guides

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!