The total US stock market remains in its primary price channel that started in early 2016. The market has seen several minor pullbacks within the rising price channel in 2017 and is a bit overdue for a correction.
The total US stock market can be broken down into two components: The largest 500 companies that make up the SP500 index and all the rest of the US companies which I like to call the non-sp500 index. These two indexes represent the TSP C and S fund.
The large caps outperform small caps when starting near market tops and the small caps outperform after market bottoms. The snapshot below shows how the small caps can advance at a steeper pace during rallies, but quickly give up their lead and more during market corrections. (Hint: we are not near a market bottom)
Currently we are in another pullback. It is hard to notice in the large caps since this rally has been relentless and most of the overbought conditions are worked off in a sideways patterns. And why shouldn’t they, with the price-insensitive global central banks still buying trillions of dollars worth of financial assets annually and corporate CEOs destroying their companies balance sheets to buyback their own company’s stocks.
When Risk Returns
The next graph is not a stock chart. The graph was produced by Dr. Hussman who spends much of his time writing about stock market valuations. I added a few comments to the chart. The valuation model presented looks at the median (middle) stock price of the SP500 verses the SP500 revenue. In my opinion, we exited the bubble era of the stock market in 2016 except we did not return to normalization, we entered Neverland.
To say the least, Dr. Hussman thinks the market is a bit pricey today and requires a 50% loss in the SP500 to simply return to bubble land.
If you look at the 2000 stock market top in the chart above you will note that the top does not look exceptionally high compared with the last 17 years. This is because most of the 2000 stock market bubble was contained in the most expensive 50 of the 500 companies unlike today’s everything bubble.
Central Bank Neverland
I often talk about central banks replacing the free market price-discovery. It is much more obvious in Europe and Japan where most government bonds have been driven into negative interest rate territory. Switzerland’s 30-year government bond has a negative interest rate – meaning you pay Switzerland to hold your hard earned funds in their bonds.
Think about it for a minute. If inflation runs 2% for 30 years and you earn 0% on a bond, then your purchasing power goes down over 70% while you hold it to duration. Good luck with that retirement plan.
When you are reading all that great analysis in the financial media which seems to be designed to confuse as many retail investors as possible, remember that today even the best analyst are confused by the markets. In my opinion this is because their solid historical models were founded in free markets that were not controlled, back-stopped and manipulated by central banks who can print money of thin air and do really dangerous things.
Imagine you are driving a semi-truck up a steep mountain pass. As you come over the top and finally begin to accelerate you decide to leave the accelerator pressed to the floor a little longer, then some more. Once you realize your truck is screaming down hill you try to hit the brake, but the truck continues to accelerate. Then you look in the side view mirror and see two other semi trucks pushing you down the hill with their pedal to the metal.
The US Federal Reserve has attempted to tap on the brakes with gradual interest rate hikes and found out that financial conditions continue to ease significantly with the US stock market and 30-year treasuries acting as their speedometer.
When they look in the mirror they see the Bank of Japan massively monetizing debt & stocks and the ECB buying corporate bonds and everything else not nailed down. The proceeds from selling to the central banks are then rolled into other financial assets to include US stocks and bonds.
The markets have had a great joy ride, but there is a good chance the Fed will be slamming on the brakes next year with more interest rate hikes than the drunk markets anticipate. If inflation accelerates as the New York Fed’s new predictive model shows, then watch out in the bond market.
As for the semi’s cargo – the stock market – it will go over the edge with the truck at the next sharp curve. The descent should be steep at that point.
Watch for sharp curves and oncoming traffic.