On most days, stocks are still driven by currency movements, markets for volatility products, and options expirations. The “tail wags the dog” as long-term investor activity has given way to computer algorithmic trading schemes that “paint a pretty tape” in a low volume environment. Mid-afternoon trading in the U.S. is like a ghost town, leaving the HFT crowd free to their own devices. However, the percentage of stocks above key moving averages is way out of line with indices flirting with their highs. The recent stock rally is marked by a lack of broad participation and is likely the result of shorts being covered by those who do not want to be on the wrong side of central banker market-supporting bloviations that have become an almost “24-7” routine. Believe it or not, the computers are programmed to buy when the bankers pontificate.
Problems are mounting and we have to laugh at the length of the list of things we are not supposed to worry about. We have been talking about corporate bonds as a primary source of trouble for some time and lately the issue has become too obvious for even Fed supporters to ignore. Lower quality credit spreads have blown out to multi-year wide levels. Leveraged loans and junk bond prices remain near four-year lows, sitting out the stock index rally. Goldman Sachs recently wrote:
“Companies in the United States have taken advantage of low interest rates to issue record levels of debt over the past few years to fund buybacks and M&A. This has driven the total amount of debt on balance sheets to more than double pre-crisis levels.”
Glad you noticed. That’s a lot of debt and corporations do not have much to show for it. For instance, trailing twelve-month S&P 500 GAAP earnings have collapsed by about 14% to $91 versus the peak of roughly $106 a year ago. This measure averaged about $87 during 2012 before QE3 got ramped up and levered stock buybacks went into full force to try to craft earnings growth out of stagnant revenues. Forgetting the QE hype and ignoring the pundits, $4 of incremental earnings is not a lot to get excited about and certainly does not justify index levels.
When we go below the surface and look at individual names, it seems like many stocks that have fallen in price by a lot are still quite rich. We can’t figure out how revenues can be maintained near recent peaks given the sea change in demand. Cheaper industrials mostly make us wonder what normalized revenues will be without China spending another $20 trillion in the next few years after “overdoing” it in a big way for the prior five. Many countries in the emerging markets were riding that nation’s coattails, as a flood of cheap dollars encouraged an amazing amount of borrowing and speculative activity to feed the China bubble.
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