Friday, December 15, 2017

Lagging Global Stocks and Extreme Valuations

The SPX rally is ongoing as the Eurostoxx,DAX, and Shanghai Composite lag badly over the past 2 months.

The stronger euro and the built in structural weaknesses in the Eurozone and China pulling back stimulus is being overlooked by rear view mirror analysts who rave about global growth and a tight labor market.  A tight labor market is not a sign of a strong economy.  It is a sign of a shrinking percentage of the working age population relative to the total.  The developed economies:  US, Europe, and East Asia are getting older, reducing the working age population, thus fewer workers available to support a growing number of elderly, keeping unemployment rate low.  That is not what strong economic expansions are made of.

That is why the Fed funds rate is 1.25-1.50%, even after a 9 year bull market.  If short term interest rates were anywhere close to 5%, you would have a deep deep recession.

The US stock market is in the most vulnerable position since 2008, as the exorbitant  stock valuations leave very little margin for error.  Even if there is just a flattening out of earnings growth, stocks will be punished because they are priced for perfection.  Reported earnings (GAAP, not the NON-GAAP operating earnings nonsense) for the S&P 500 is $107 for the trailing 12 months as of November.  The market is currently priced at a trailing P/E of 25!  The only time you had such a big multiple during an earnings expansion was in 2000, when the S&P went up as high as P/E of 28.  Even the top in 2007 was less expensive, with a trailing P/E of 18.

So you have a high probability of a bear market within the next 2 years, just based on the optimism and high valuations, with low earnings growth.  By the way, stocks are priced off of perpetual earnings, and these corporate tax cuts will last 8 years before they expire.  The budget deficit will be so massive in 8 years that I am sure there will be a BOJ type of ongoing QE by the Fed at that time to keep interest rates low.

The VIX has gotten obliterated today.  It is now down to 9.5, near the lowest levels of the year.  The VIX shorts have been getting paid handsomely, even without VIX going lower, just by rolling over their shorts with the steep contango.  You would figure that the VIX longs would have had enough and demanded a flatter VIX curve for taking on long volatility positions.  It seems like there is more risk holding a long volatility position than a short one!  Its an upside down world, as the lack of volatility is perpetuating ever larger vol adjusted stock positions at funds, keeping the uptrend going.

It looks like we will finally get the tax cut bill passed next week.  There has been so much hype about these tax cuts, that I can't imagine that they are not priced into the market.  Isn't that what the Trump trade was all about since November 2016?

Shorts will have their time in the sun soon enough.  The bitcoin mania has masked what is probably the more insidious bubble:  US stocks.

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