Executive Summary
Over 50% of the stock options sold each day for the S&P 500 expire the same day. Translation, speculators are gambling on the daily movement of the market. In the graph below by economist Dr. John Hussman, one can see the market is as overvalued as just before the Great Depression. Corporate earnings are concentrated to five companies (Amazon, Google, Meta, Microsoft and Nvidia). As Bob Farrell stated, markets are weak when concentrated to a handful of companies. When speculation changes to panic, the risk will be revealed.
Please continue to The Details for more of my analysis.
“What we do know is that speculative episodes never come gently to an end. The wise, though for most the improbable, course is to assume the worst.”
–John Kenneth Galbraith
The Details
As described in recent newsletters, the S&P 500 Index, by some measures, is now more overvalued than ever before. Not only is the index overvalued, but the daily activity resembles a casino, where over half of the daily stock options sold for the S&P 500 expire that same day. The magnitude of this speculation is mind boggling. And, with almost 90% of first quarter earnings results reported, both stock prices and earnings continue to be driven by a handful of companies, adding more risk to the “market.”
The following graph from economist Dr. John Hussman represents the methodology, which his testing reveals, is most correlated with subsequent actual returns. In the simplest terms, this methodology is similar to the price of the S&P 500 divided by corporate revenue, with a few adjustments. The graph illustrates how the current valuation level is hovering in the same neighborhood as the 1929 peak, and far exceeds the top of the Technology Bubble in 2000.
Just a reminder that after the 1929 peak, the Dow plummeted over 86%, and after the Technology Bubble, tech stocks, as represented by the Nasdaq 100, fell over 80%. Will this time be different?
According to data on the SpGlobal.com website, the S&P 500 net earnings for the first quarter of 2024, compared to the same quarter last year, rose by a mere 1.0%. FactSet reported that of the total earnings growth announced for the first quarter, a whopping 64% came from just five companies: Amazon, Google, Meta, Microsoft and Nvidia. The remaining 495 companies saw earnings growth drop 6%!
Market guru and head of research at Merrill Lynch for decades, Bob Farrell, outlined “10 Market Rules to Remember”. Although, all are currently applicable, the one that stands out in light of first quarter earnings is Rule #7, “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.” Based upon the above data, I would say five companies out of 500 is definitely considered “narrow”!
So, here we have a brief picture of a stock market, pushed ever-higher by gamblers betting on single-day outcomes, in a market with revenue more disconnected from prices since just before the Great Depression. And earnings growth is falling for most companies, yet five large corporations are holding up the index.
The combination of the above ingredients highlights a market that is filled with extreme risk. Jerome Powell, Chair of the Federal Reserve, has done his best job possible attempting to talk the market up. However, there will come a time when speculators lose confidence, at which point there will be no buyers. When this happens, it will be like someone yelling “fire” in a crowded theater with only one exit!
The S&P 500 Index closed at 5,303, up 1.5% for the week. The yield on the 10-year Treasury
Note fell to 4.42%. Oil prices rose to $80 per barrel, and the national average price of gasoline according to AAA fell to $3.59 per gallon.
© 2023. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.
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