Thursday, August 6, 2015

Economic Red Flags ......MORE PESKY FACTS!

Economic Red Flags

Red flags that suggest to me a more pronounced downturn may come sooner rather than later:

Glass half empty. In our analysis, the market has increasingly been reacting negatively to news. We see little sign of a market climbing a wall of worries.

In our analysis, market breadth has deteriorated. It was last in the late 90s that the Nasdaq reached new highs, but the number of shares reaching new lows on a fifty-two week basis exceeded those reaching new highs. In plain English, few stocks are driving rallies, a sign of a market that's tired.

Stale revenue. Too many firms, in our assessment, don't have revenue growth.

P/E ratios. All else equal, low interest rates warrant higher price-to-earnings (P/E) ratios as future earnings are discounted at a lower rate. As interest rates rise, we expect "multiple compression", i.e. lower P/E ratios.

Share buybacks. Earnings per share for many businesses move higher despite stale revenue or higher costs because of share buybacks. As many firms borrow money to buy back shares, buybacks become much less attractive as rates rise. They'll have the additional headwind that they'll then have to pay higher interest on the money they borrowed to buy back their shares.

Whisper numbers are back. Some tech stocks get burned for not making "whisper numbers," i.e. elevated expectations that go beyond what analysts have forecast. Investors expect that optimistic expectations are beat, a recipe for disappointment.

The strong dollar. The strong dollar is another headwind, as well as a great excuse when companies miss earnings, masking underlying weakness.

Global slowdown. In our analysis China is slowing down; many firms that have tried to sell to the ever more affluent Chinese middle class may be facing headwinds.

Valuation. We don't think stocks or bonds are cheap. We list this last, as everyone has his or her own preferred measure of valuation (in bull markets, investors are very creative in how they justify valuations). All I would like to add here is that any pundit that tells you "stocks can go up 10% from here" has no clue what he or she is talking about, in my experience, that's what pundits say if they have stocks to sell.

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