The opening of February launched the RISK-ON rally in all the stock market and thus the TSP equity funds and at the same time a retreat of the TSP F fund began as interests started to climbed off their lows. Also at the same time, credit spread began to contract after widening since June 2014. One of the drivers of this reversal appears to be the temporary bottoming of the price of oil. It also helps that the European Central Bank announced expanded asset purchases in late January although they will not begin purchases until March.
From a fundamental point of view, the energy sector was responsible for the largest share of downgrades in future earnings and a possible bottom was helpful from this perspective. The market obtained upward momentum and is now establishing new highs with good market breadth. But the market is now overbought and over-valued in terms of both trailing and forward earnings. The market prices today match Goldman Sacs end-of-year estimates (2100 for the S&P 500) and from recent comments they do not appear to be planning to raise them. Zero Hedge quoted Goldman’s chief strategist David Kostin statement on valuations.
Stocks with attractive valuation are rare in the current environment of stretched share prices. The aggregate S&P 500 trades at 17.3x forward EPS and 10.2x EV/EBITDA. The only time during the past 40 years that the index traded at a higher multiple was during the 1997-2000 Tech Bubble. The median stock sports a P/E and EV/EBITDA of 18.0x and 11.0x, respectively. These valuations rank in the 99th percentile of both P/E and EV/EBITDA multiples since 1976.
The S&P 500 is trading above the top of our best-guess price channel and the Bullish Percentage has risen to within a couple of percent of its peak during four out of the last five market rallies. While it is possible the market can continue to advance and the bullish percentage can climb above 76% going forward, it makes little sense from a risk perspective to add to equity positions at this level. It actually makes more sense to begin to determine when the current rally has run its course and to lighten up on equities since future earnings estimates are being revised down significantly.
S&P 500 Bullish Percent Index
The percentage of companies issuing negative guidance for the first two quarters of 2015 (Oct 2014 – Mar 2015) is above average with predictions of year-over-year declines of 4.1% and 1.1%, respectively. This guidance is down from positive 4.0% and 5.2% on 31 December 2014 or a drop of 8.1% and 6.3%. Yet analysts are still projecting record-level EPS for the 2nd half of 2015. The Forward P/E is already at a 10 year high and any downgrades to the 2nd half earnings will send it much higher at current market prices.
So who is buying? First are the automatic funds being deducted from paychecks and deposited in retirement accounts. Then typically mom and pop have the highest exposure at market tops and lowest at market bottoms, so they are adding based on the media headlines. Many market technicians and trading algorithms do not pay attention to fundamentals or the news and are momentum creators. Then as I wrote about last week, the CEO of companies are spending 54% of earnings on stock buybacks to squeeze out a larger salary for themselves. And as we see in the charts, funds shifted from bonds back to equities. Note: The shift does not represent TSP participants shifting from the F fund to the equity funds, but global investors as represented by the indexes and securities the TSP funds track shifting exposure.
Can the stock market keep rising? Yes, the market can stay over-valued and over-bought for a long time. We are also in the strong season for equities in what is usually the best year of the four-year election cycle for stocks. The market is currently RISK ON and I certainly did not predict the upside breakout based on the declining forward earnings situation. But then again, the markets are detached from fundamentals so anything is possible to include further compression of risk premiums (further over-valuation). While I do not expect a major market crash anytime soon, a good correction is still possible and with all the mentioned concerns I am not adding to equities in my Expedient model.
My seasonal models remain 100% in equities until the Spring as they are designed to do and the last chart above represents the Advantage W model that holds the whole US market (TSP C and TSP S fund) since it entered the market at the close of 27 Oct 2014. I hope the funds end the strong season for equities at these elevated levels, but I also expect a roll coaster ride. The seasonal models tend to beat most investment advisors over the full market cycle, and I may not be any different. But at these valuation levels with declining forward earnings estimates, my risk tolerance is very low presently. But it will be even lower come spring and summer.
Categories: TSP Charts