Stocks are tumbling in Russia, Brazil, Chile, South Africa, Australia and Canada due to economic weakness in China. Meanwhile, the Vanguard Europe ETF (VGK) remains roughly 5.5% off of its May high, as the feel-good effect of $1.3 trillion in European Central Bank stimulus subsides.
In truth, risk assets from across the spectrum are fading. Exchange-traded vehicles as diverse as iShares High Yield Corporate Bond (HYG), iShares Russell 2000 (IWM), iPath Commodity (DJP) and Vanguard FTSE Emerging Markets (VWO) are all battling downtrends.
Historically, there is a strong correlation between sharp declines in a wide variety of riskier assets and the S&P 500. Here in 2015, however, the S&P 500 has been nearly as defiant as those investors who have placed all of their eggs in the benchmark’s basket. How defiant? The S&P 500 SPDR Trust (SPY) is a mere percentage point off of its all-time record.
The popular S&P 500 benchmark has several sub-components (e.g., energy, materials, industrials, etc.) that have already succumbed to downtrends. Still, the large-cap U.S. stock proxy has held firm. On the flip side, however, a cornucopia of warning signs suggest caution. Signs of a market top are evident in corporate data, respected valuation methods, economic facts, overall U.S. market price movement and investor sentiment.
Here are 15 indications that the S&P 500 is near a market top:
CORPORATE
1. Dividends are Decreasing. According to S&P, there were 696 reported dividend increases in the second quarter of 2014. In the second quarter of 2015? Only 562. That represents a 19.3% decrease. Equally disconcerting, 57 corporations decreased their dividends in the first quarter whereas 85 companies dropped the bomb in the second quarter. Dividend decreases have now reached their highest point since 2009.
2. Questionable Accounting. Thomson Reuters is reporting that second-quarter earnings growth should come in at 1.2%. That’s relatively flat, but it is not necessarily the end of corporate profitability. Or is it? According to data from S&P Dow Jones Indices, Q2 profits should chime in at $22.85 a share. That’s down a dramatic 15.8% from one year earlier. Accounting shenanigans? That depends upon who you ask. S&P’s data employs generally accepted accounting principles (GAAP) were all expenditures are included. Thomson Reuters? They get their numbers from the analysts who often pull out costs when the corporations themselves exclude those costs.
3. Buybacks may be the Only Support. Stock buyback programs have never been about identifying attractive valuations. They’re about the short-term allocation of inexpensively borrowed capital to reduce share count, improve perceived profitability per share and gloss over revenue declines. Unfortunately, when revenue shortfall meets with higher corporate borrowing costs (a la wider credit spreads), those price-insensitive repurchase programs wind up becoming the only support for the market itself. Bank of America/Merrill Lynch recently broke down net stock acquisitions/dispositions by client type and found that corporations are the only net buyers.
4. Corporate Debt Levels Are Hitting Extremes. Are companies sitting on stockpiles of cash? Borrowed cash, and probably not as much as many folks think since so much of that cash went into buying back stock shares. Corporations are highly indebted. They’ve even increased their debt obligations by 25% since 2009. In fact, non-financial corporations are more leveraged at 37% than they were in 2007 at 34%. What happens when the borrowing costs rise on the 7-year corporate credit bonds that have been issued? Too much leverage is a probable warning sign.
5. IPOs Oh No? The last time that the S&P 500 experienced a meaningful correction of 19%-plus occurred during the euro-zone crisis of 2011. Yet they battled back to end the year at the break-even point. Conversely, IPOs in the Bloomberg IPO Index fell 23.3% in the calendar year 2011. So far in 2015, the Bloomberg IPO Index has already hit a correction with declines of more than 10% year-to-date. Depreciation from the November 2014 highs is even greater.
VALUATION
6. Exorbitant P/Es, Forward Or Backward. Goldman Sachs recently dispelled the myth that low interest rates alone justify higher price-to-earnings ratios. According to their data, the forward 12-month P/E averaged 11.2 when real interest rates were between 0% and 1%. Forward P/E today? 16.7. Stocks would need to drop by 1/3 in value to revert to the mean. 12-month trailing P/Es, you ask? According to S&P, the index is pushing 22.2 with the recent decline in S&P’s estimates of earnings. Reversion to the mean here would also require a 33% decline in current pricing.
7. Unsustainable P/S Ratios. Ed Yardeni pegs the S&P 500 at 1.85. That’s the 2nd highest in history when the P/S surpassed 2.0 in 2000. With two consecutive quarters of declining sales (a.k.a. “a revenue recession”), it is difficult to see how that ratio does not get more out of whack.
8. Market Cap-to-GDP is Scary. Scores of analysts as well as investing oracles like Warren Buffett revere this valuation methodology. And why not? According to fund manager, John Hussman, the indicator boasts an impressive track record of 92% accuracy with respect to subsequent 10-year total returns for the total U.S. stock market. As of this moment, the Wilshire Total Market Index market cap is roughly $21.85 trillion. That’s 125% of GDP. By this metric, the US stock market is only expected to annualize at about 0.3% with returns from dividends over the next decade. (Note: Market cap uses the Wilshire 5000 rather than the S&P 500.)
ECONOMIC