Guest Post: The Market In Pictures

Tyler Durden's picture

Submitted by Lance Roberts of STA Wealth Management,

I recently posted a piece entitled "The Economy In Pictures" wherein I shared a series of economic charts using annualized trend analysis.  The purpose of the post was not to espouse a personal viewpoint on the health of the economy, or lack thereof, but to allow you to view the data and draw your own conclusions.  As I stated:

"With the economy now more than 4 years into an expansion, which is long by historical standards, the question for you to answer by looking at the charts below is:

'Are we closer to an economic recession or a continued expansion?'


How you answer that question should have a significant impact on your investment outlook as financial markets tend to lose roughly 30% on average during recessionary periods.  However, with margin debt at record levels, earnings deteriorating and junk bond yields near all-time lows, this is hardly a normal market environment within which we are currently invested.


Therefore, I present a series of charts which view the overall economy from the same perspective utilizing an annualized rate of change.   In some cases, where the data is extremely volatile, I have used a 3-month average to expose the underlying data trend.   Any other special data adjustments are noted below."

This week I bring you "The Market In Pictures"

There is currently a debate being waged on Wall Street.  On one side of the argument are individuals who believe that we have entered into the next "secular bull market"  and that the markets have only just begun what is an expected multi-year advance from current levels.  The other side of the argument reiterates that the current market advance is predicated on artificial stimulus and that the "secular bear market" remains intact, and the next major reversion is just a function of time. 

The series of charts below is designed to allow you to draw your own conclusions.  I have only included commentary where necessary to clarify chart construction or analysis.


Valuation Measures

The following chart shows Tobin's "Q" ratio and Robert Shillers "Cyclically Adjusted P/E (CAPE)" ratio versus the S&P 500. James Tobin of Yale University, Nobel laureate in economics, hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm's assets.  Dr. Robert Shiller, also a Nobel Prize winning Yale professor, created CAPE to smooth earnings variations and volatility over time.  CAPE is calculated by taking the S&P 500 and dividing it by the average of ten years worth of earnings.  If the ratio is above the long-term average of around 16x, the stock market is considered expensive. Currently, the CAPE is at 24.42x, and the Q-ratio is at 1.00.


My friend Doug Short regularly publishes Ed Easterling's valuation work.  Ed Easterling, Crestmont Research, has done extensive studies on valuation and resulting long term returns.


 The next two charts are variants on Robert Shiller's CAPE.  The first is just a pure analysis of CAPE as compared to the S&P 500.


The next chart shows the deviation of valuations from their long term average.


Are stocks truly reflecting the economy?


One of Warren Buffet's favorite valuation measures is Market Cap to GDP.  I have modified this analysis utilizing real, inflation adjusted, S&P 500 market capitalization as compared to real GDP.


Since the stock market should be a reflection of the underlying economy, then the amount of leverage, or margin debt, in the market as a percentage of GDP could provide an important clue.


Deviation Measures

The following charts are measures of deviation from underlying trends or averages.  The greater the deviation from the long term trends or averages; the probability of a reversion back to, or beyond, those trends or averages increases.  The first chart is the deviation of earnings from the underlying long term growth trend of earnings.


The next chart is the deviation in price of both the S&P 500 and Wilshire 5000 from the 36-Month moving average.  For more discussion on this chart read this.


The chart below is the same basic analysis but utilizing a 50-week moving average which is a more "real-time" variation.


The volatility index (VIX) is representative of investors "fear" of a correction in the market.   Low levels represent investor complacency and no fear of a market correction.


Just For Good Measure

This past week John Hussman tweeted this chart of the S&P 500 that lists all of the warnings signs of a crash that we are experiencing now.  


"Anatomy of textbook pre-crash bubble. Don't rely on further blowoff, but don't be shocked. Risk dominates. Hold tight."

This analysis, along with the economic data I posted recently, tells us much about where we are within the current economic and market cycle.  While it is certainly easy to be swept up in the daily advances of the stock market casino, it is important to remember that eventually the "house always wins."  What has always separated successful professional gamblers from the weekend sucker is strictly the difference of knowing when to cash in your chips and step away from the table.

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DoChenRollingBearing's picture

IMO, this is a great time to be selling.  I will start tomorrow with some sales of stocks and ETFs now that we are back and do not have company.  It worked out OK that I did not time my market sales 5 - 6 weeks ago.

slotmouth's picture

A lot of smart money sold off the day of the twitter IPO when the retail investor was preoccupied.  Look at the volume and direction on that day.

flacon's picture

I remember last May when supposedly the "smart money" had exited the markets.... they missed a 10% move up in the S&P. 


How come smart money is always exiting the S&P and smart money is always flowing into gold... but the price of S&P goes up and the price of gold goes down?

zipit's picture

Be an idiot before the crash or after the crash, your choice.  Or maybe do both :)

Ghostdog's picture

I was on the CBOT floor leading up to the 87 crash, the 92 S&L Scandal and then off the floor managing money in 2000 and 2007 and can tell you that this current market has been easily the most difficult to project. Chiefly because you have a guy on one side backstopping the entire market and its all about reading his mind. A lot of really smart people have been wrong on it but I do believe in the big picture they will be vindicated even though its true, they will have left a lot of money on the table.

So what do you do? I think you have to have some hedged exposure to the market in the event this turns into a Zimbabwe deal and you need a wee bit in physicals. (Im not a gold bug as I think deflation will win this but I know I cant tell the future) Some land exposure and some sort of hedged short positions and the rest in some sort of currency because barring the currency going away, there will be so many deals on the table when this thing ends, you will truly be able to set up your retirement trade. As 3 crashes in 14 years will be enough to wipe most people out.

Im a firm believer in relative weatlh. I dont need to be the richest guy, I just need to be richer than most people. If everything collpases I will be richer than most with the physicals. Even though I dont have a lot it will still be more than 95% of the people. If the market continues to go up, I will be richer than most as I will be keeping pace with those that are sitting in sucker mutual funds

Remember Flacon that as the market moves higher so does risk of a correction (no one has ever gotten rich buying high and selling low) as we have had at least a 30% correction every 6 to 7 years over the last 55 years (sans 1993) and just as the market moves lower your risk decreases. At some point this will end with the Fed stopping their games and then we will see whats real. I dont see one single fundamental indicator that is getting better. We have successfully put lipstick on a pig but I still dont think she can fly. We shall see.


Cognitive Dissonance's picture

And the insanity continues. Personally I like to view the market in finger paints. /sarc

RaceToTheBottom's picture

All this research in order to find order in disorder.... 

It is easy, I see only QE

Tinky's picture

Rather than charts, I find that images such as this encapsulate the state of the market most succinctly:

dcohen's picture

Heavy load, Benny & Yelly shipping all the gold to their friends overseas, ready to leech the next victim.

chubbyjjfong's picture

She broke up soon after that was taken, a harbinger perhaps.

Madcow's picture

Beginning of a new bull - or start of deflation collapse ... Gold is very clearly telegraphing the latter. Functional money supply peaked out a couple years ago - and now its time for the abyss.

The only way to have a new "boom" would be to 10X the money supply - by inducing a new era of borrowing to buy assets - probably in Asia - where there is fresh debt-taking capacity. But they're going to have to hurry  - before the clock runs out on the derivatives time bomb. My guess is the're not going to make it in time.  Like Evel Knievel mis-judging the distance and not having the speed to get acrosss the jump.  Japan, Europe, and now the USA - trapped the deflation fly paper.

So I'm holding on to (mainly) cash and getting short.  The derivatives apocolypse is but moments away.  If i saw gold moving much much higher i might change my mind, but i just dont think that's going to happen.

"Daddy - tell me that story about when there were office jobs and grocery stores again" 

disabledvet's picture

Contrary to popular myth the Fed tightened this summer. Oh, and Alan Greenspan had no trouble deep sixing the whole idea of economic growth either...let alone "financle-ization." Nothing another speculative blow off can't solve? Hmmm. Where's the SEC in all this again?

Stuck on Zero's picture

Time to dust off James Glassman's 1999 book: "Dow 36,000."


DOGGONE's picture

Define "Leadershit".
Include in your definition the absence of this from the public eye:
The Public Be Suckered

Oldwood's picture

I think the manic nature of it is what stimulates many in the market in the first place. It gets their adrenaline going. Life on the it higher and lets see how she goes. Unfortunately most of our lives is in some way are dependant upon these crazy fucks and we can do nothing about it. This is why I BEG people to back the fuck away. It is no different than those fools playing games with nukes and acting like it is all about them. The world would be a better place if we just bought them all ferraris without brakes and told them to go for it. Hunger games for the sociopaths.

catch edge ghost's picture

There is no down.  I mean spoon. Whatever.

q99x2's picture

FED market software connected to an infinite money supply..


silverserfer's picture

Sabbath -Crazy Train

trade with your left arm held in the air like Ozzy singing in your long johns. 

DCFusor's picture

Even better than garbage...(and that's saying something)  Note the pyramid at the end...

Goldilocks's picture

In Flanders Fields - Song and Slideshow (2:28)

exartizo's picture

...actually Lance? that's supposed to read: "step away from the table and cash in your chips". Classic Chicken Or The Egg Theory. Which came first? stepping away from the table? or cashing in the chips? ...seems obvious that stepping away from the table came first imho.

The worst trader's picture

Just ask the POTUS, he knows best.

WhiteNight123129's picture

THere is too much debt (which is the finanical asset of someone else) to GDP (circulation of good and services and commodities).


This can be rephrased in the following:

There are too many financial assets in relation to the cumulative amount of transactions in the real economy.


Two resolutions to restore the ratio

Either finanical assets go bankrupt, or the price of everything shoots to the moon (GDP targeting). Either way the ratio is restored back to more appropriate levels.

So financial assets can be creamed 1929 style without printing or can be creamed by inflation.

If you want to invest put your savings in a place where there is little amounf of financial assets to GDP (Vietnam or Buram- Maynmar).

Elsewhere you should cling to present goods (gold, silver, sugar, wheat, rice).


moneybots's picture

"On one side of the argument are individuals who believe that we have entered into the next "secular bull market"  and that the markets have only just begun what is an expected multi-year advance from current levels.  The other side of the argument reiterates that the current market advance is predicated on artificial stimulus and that the "secular bear market" remains intact, and the next major reversion is just a function of time."

Looking at the chart showing the Wilshire 5000, it looks like the secular bull market never ended.