EC Deteriorating U.S. Stock Market Condition & 2016 S&P 500 Target Price From 15 Institutions

It is sagacious to eschew obfuscation – so let’s be direct – the US stock market sucks right now.

There are a number of problematic issues for stocks at this time, but let’s look at three key factors, as if they are three legs of a stool:

  • Treasury yield curve
  • Fundamental company operations
  • Stock index and index constituent behaviors

There are many factors that influence these three things, but they are too many and their specific individual impact is too uncertain to be clearly interpreted. However, they are all assimilated into the markets and manifested by the three legs of our stool.

2015-12-11_1

What is the condition of the stool (the stock market)?

  • Treasury Yield Curve (positive): The curve is favorable to company operations and investment, to investor risk taking, and to household purchases on debt
  • Company Fundamentals (negative): Revenue is declining, profits are declining and profit margins are declining, and credit worthiness of an increasing number of companies is in question (energy is a big factor)
  • Index Behavior (negative): Stock returns are flat for the year, a narrow group of large companies is supporting the indexes while most stocks are doing poorly, and index intermediate price trends are negative.

We all know what happens to a stool when a leg is missing or one or two are too short – that is where we are right now in the stock market.

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IMPLICATIONS FOR US STOCKS EXPOSURE

This does not mean a Bear market is on the way, nor does it mean the stock market will not rise next year. However, if does mean there is damage that needs to be repaired before the market can mount a sustainable advance. That repair will take some time – not days, not weeks; probably months, and possibly quarters.

The condition needs monitoring, and that is just what we are doing.

At this time we counsel above average cash positions, and below average allocations to each of bonds and stocks.

For those accounts where we have discretion, we raised extra cash back in July, and are waiting for the post-Fed rate rise period, and for US stocks to exceed their July high, before re-committing significant funds. In the interim, we may nibble here and there on individual securities that look particularly attractive

We agree with Bill Gross who recommended in his last monthly letter that both credit bond and equity exposures should be reduced.

We recommend a strong tilt to large-cap, high quality stocks with strong brand equity, solid financial condition, above average yield, consistent dividend growth and reasonable valuation multiples versus growth expectations. To the extent that the next year or so produces low total return, the dividend income component becomes relatively more important.

Actually, we always favor such stocks, so the change aspect to this is to reduce current exposure to momentum stocks, high leverage stocks, small-caps, non-yielding stocks, and lower quality stock generally. With respect to bonds, we suggest reducing exposure to low quality, high yield bonds until the bond market settles a bit.

In a period rising interest rates and slowing economies, companies with solid balance sheets with low debt-to-equity are a safer choice.

YIELD CURVE

The current yield curve is supportive of stocks. This chart shows the difference between a supportive yield curve, such as we have today; and one that is inverted and bad for stocks, such as we had in April of 2007 leading up to the Bear market.

(Click on image to enlarge)

Check off the box for a positive yield curve stool leg.

COMPANY FUNDAMENTALS

Sales are declining. Profit margins are declining. Reported earnings and S&P calculated operating earnings are declining.

These three charts show those dimensions (in green, left scale) versus the S&P 500 index price (in red, right scale).

Check the box for a negative fundamentals stool leg.

For a little more color, here is a table that compares some internal breadth data for key S&P market-cap indexes:

You can see that the larger-cap indexes are in better shape than the smaller-cap indexes: S&P 100 (mega-cap) better than S&P 500 (large-cap) better than S&P 400 (mid-cap), better than S&P 600 (small-cap).

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Disclosure: None.

"QVM Invest”, “QVM Research” are service marks of QVM Group LLC. QVM Group LLC is a registered investment advisor.

IMPORTANT NOTE: This report ...

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Chee Hin Teh 4 years ago Member's comment

Thanks for sharing