Nearly halfway through 2016, most of the issues we faced at the beginning of the year remain today. With little overall market movement, the two most popular averages, the S&P 500 and DJIA, are little changed on the year – both up a small yet positive 1.5%.
The S&P 500 is lower than it was in December 2014. Perhaps not so coincidentally, the Fed ended QE3 in October 2014.
At the same time, the global central banks continue to message, we’ve got your back, yet there are signs our collective faith in their power is waning.
I would feel much more at ease if valuations were reasonable. Unfortunately, they are not. At the end of May 2016, median price-to-earnings ratio (P/E) stood at 23.23. This compares to a 52.3 year average of 16.9. The median P/E was 22.0 on December 31, 2015 and it was 11.0 at the last crisis low in 2009. Here is a look once again at a few select periods in time. Buy low, sell high you say? Have a look at some evidence.
So let’s handicap the trading range this way. Fair value puts the S&P 500 Index at 1526.59. Undervalued (as measured by a one standard deviation move below fair value) puts the downside risk at 1061.03. Overvalued (a one standard deviation move above fair value) puts the upside target at 1991.21. We are trading near 2075 at the time of this writing.
Trading range:
- Upside overvalued target: 1991.21
- Fair Value: 1526.50
- June 16, 2016 close: 2078 (4.4% above fair value)
The macro issues remain large (debt, deflation and aging demographics). Much of the developed world is in recession though not yet here in the U.S. Recessions matter to our collective wealth. That is typically when the large market dislocations occur and I believe one is nearing (2017 or sooner). So we stand watch.
Keep your eye on these six key recession points:
- Global trade has gone negative – that has never happened without a recession.
- The year-over-year change in Wall Street consensus 12-month earnings forecasts goes negative. When this happened in the past, a recession always occurred. It went negative at December 2015 quarter-end.
- Copper is signaling the global economy is in trouble.
- We have now had six consecutive quarters in earnings decline (year-over-year) – signaling recession.
- In the “not yet but we must watch closely” category: Recession occurs when the S&P 500 falls below its five-month smoothed moving average line by -4.8%. Since 1950, that measure has predicted 9 of the 11 recessions at or near the recession’s start.
- In the “not yet but we must watch closely” category: A negative yield curve has always signaled recession.
Risk is high and I believe we should be thinking a lot more about wealth preservation and a lot less about stretching for that extra base. Can the market trend higher? Sure. But at some point, investors are going to have that very difficult argument with reality. Let’s not be one of them.
By Steve Blumenthal | For the rest of the story see On My Radar: Kumbaya My Friend, Kumbaya.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.
