Wall Street’s Calling The Sheep: Buy The Dip Now, Join The Slaughter Later
by David Stockman, Contra Corner Yes, indeed. They bought the dip again, nudging the S&P 500 to another “record close”. This time the magic number was 2097 and its represented a tiny gain of 0.3% from the last record close, which was 2090 on December 29th. Needless to say, there were a lot of thrills and spills in between. As shown below, the broad market index has been staggering upward like a drunken sailor for the last three months. Just about 90 days ago on November 17, in fact, the S&P 500 hit a then record high of 2073 before plunging on five separate occasions by 3-4% toward the 2000 marker during the interim. So it all adds up to a 1.2% net gain since mid-November. Call it a 4% annualized rate. The question at hand, therefore, is who in their right mind would want to play on the jagged curves shown below for 4% a year? Indeed, the sharp dips here pictured are not even half the story. The real risk/reward equation is the prospect of gaining perhaps 4% when buying the dips versus a 30-50% bloodbath when comes the next slaughter.
The picture above is surely the work of robo-machines and days traders, pivoting sharply and frequently between a narrow corridor of chart points. But that obvious scam does not stop Wall Street from calling the retail sheep, and in that regard they have been more than successful. The sheep are not only buying the dip, but doing so in the most hazardous, high-beta precincts of the casino. For example, during the last 90 days while the broad market has oscillated forward by just 1.2% on a net basis, the Russell 2000 has been in a sharp uptrend since its mid-October low. Accordingly, it has gained 16% and now sits at an all-time high.
It cannot be said that cheap valuation is what brought the sheep scampering into the Russell 2000 or even the broad market for that matter. The big caps are now trading at 20.4X LTM (latest 12 months) reported earnings, and that in itself is at the tippy-top of the historical range. In fact, the $102 per share of earnings for the S&P 500 reported for Q4 thus far represent a gain of just 17% from the $87 per share of reported LTM earnings back in Q4 2011. During that interval of tepid earnings advance—-aided by massive stock buybacks with cheap debt and big foreign earnings translation gains owing to a then weak dollar—-there was nothing at all tepid about the S&P 500 index. It began Q4 2011 at 1100, meaning that it was up by 90% at the most recent high. Can you say multiple expansion? Big time! Self-evidently, when the stock price index rises 5X faster than per share earnings, the PE multiple must soar. It did—–rising from about 13.5X during the last quarter of 2011 to more than 20X today. Absent the drastic upwelling of animal spirits embodied in the PE expansion, therefore, the S&P index would be at only 1375 today. This implies that upwards of 75% of the stock market gain since late 2011 has been due to multiple expansion alone.
Yet even that cannot hold a candle to the high beta neighborhood were the Russell 2000 stocks dwell. These are all small cap companies with market values well under $5 billion. They are inherently riskier than their big cap counterparts, are preponderantly domestic operations and contain a goodly fraction of names which have highly volatile performance histories or no net profits at all. But never mind. The index is now trading at nearly 60X LTM reported earnings. So why have the sheep piled back into the Russell 2000 at this kind of nosebleed valuation? Very simply, the old one-two punch of Fed monetary accommodation and Wall Street sell-side propaganda have carried the day. With respect to the really fast money, there is untold (and unreported) billions available from prime brokers to fund hedge fund positions in the Russell 2000. But even for the slower-footed retail investor, there has never been such a cornucopia of cheap margin debt available to fund speculation in risk assets. As shown below, margin debt relative to GDP is now at an all-time high of 2.91%. This is nearly 3X the average rate of 1.0% since 1958 and, even more ominously, exceeds the peak ratios registered on the even of the dotcom and subprime busts earlier this century. Continue Reading>>>