Dec 16, 2013

Last week I posted about the high probability of a bullish end to the year. In an effort to be balanced and show all sides, this week I would like to provide a look at the bearish view. Cullen Roche of the wrote a nice bearish piece that is worth reposting. I know it’s not fashionable to be bearish about anything these days, but I guess I just can’t kill the old risk manager in me. Given this predisposition, I wanted to highlight some potentially bearish indicators that have been popping up lately.  I’ll highlight three such indicators:

1)  The first indicator is from Thomson Reuters.  It shows the S&P 500′s negative-to-positive guidance trend.  According to TR the current reading for Q4 of 11.4 is at its worst level since they began recording the data.  Of course, this sets the bar low for Q4 earnings, but we have to wonder how much this will filter into 2014 earnings where analysts are currently expecting double digit growth.

2)  The second chart is the Investor’s Intelligence bull/bear difference.  This is a sentiment reading that tends to reach extremes when sentiment is heavily skewed in one direction or the other.  The current reading just shy of 40 has not been seen since summer of 2011 before the last significant sell-off.

3)  The last indicator is a potential indication of how stretched the two above indicators have become.  It shows the S&P 500′s year-to-date return broken down by actual earnings growth and multiples expansion. Earnings growth is what the actual growth in earnings while multiples expansion represents what buyers are willing to pay for this stream of earnings.  As sentiment has soared investors have become increasingly willing to pay for a reduced share of EPS growth.

The bottom line here is that from the recent 26.5% return on the SP500, only 17% was due to an increase in corporate profits. The rest is investor enthusiasm and willingness to pay higher prices to own stocks.  I don’t know about you but being the tightwad I am I prefer to not overpay for anything …. Even stocks.

Some food for thought….