| Framework for Understanding Market Tops and Bottoms Posted: 06 Apr 2014 10:39 PM PDT Last week I received an excellent article from Variant Perception on "Market Tops", and have permission to excerpt some of it. Here is a link to the summary page of Understanding Market Tops. What follows are a few snips from the full report. Framework for Understanding Tops
In the following table, we summarize the signs of market bottoms and tops.
The signs can be divided into the following categories: corporate, valuation, economic, market and sentiment. Clearly many signs of a top are in place, but there are many characteristics that are currently missing. In the coming pages we will look at each category separately.
click on any chart for sharper image
Today the market shows many of the elements that are present near market tops. In particular, sentiment is extremely bullish, investors are long and leveraged, and valuations are extended on a wide variety of measures. However, leading economic indicators are still not negative, and so far breadth and technicals have not deteriorated. The medium-term stock market returns are likely to be negative due to excessive valuation, but there is no imminent sign of a medium-term market top.
Tops are a process, not a single event. They tend to last a long period of time, and markets whipsaw traders and disappoint bears and short sellers. For example, many signs of a market top were clearly visible in late 1998, but it was not until the end of 2000 that most major market indices started to collapse. Likewise, many elements of a market top were evident in late 2006, but markets didn't begin to collapse until very early 2008.
CORPORATE ACTIVITY: WE'RE SEEING TYPICAL SIGNS OF MARKET TOPS
CEOs are bad capital allocators of corporate cash and provide contrarian clues, but insiders are much better at providing insight with what they do with their own cash.
A CEO should issue shares when they are overvalued and buy them back when they are undervalued. Likewise, a CEO should buy competitors when they are cheap and avoid overbidding when prices rise. Unfortunately, most share buybacks and most mergers and acquisitions happen at very high prices near market tops, and companies divest units and issue shares near market bottoms. Insiders, however, are smart. IPOs surge near market tops as insiders sell out. Also, near market bottoms insiders buy their own stocks.
The fewest buybacks in each cycle happened when stocks were cheapest. It is impossible to make this up. CEOs are just like "dumb money" retail investors, buying high and selling low.
If you look exclusively at the US, you can see that M&A levels are very frothy and are near where they were in 2007. Greed is alive and well in the US. They are significantly below levels seen in 2000, but that was the biggest M&A wave ever and marked the peak of telecom, media and internet bubble. It included the likes of AOL's purchase of Time Warner and other mammoth deals.
One area that currently is frothy is the biotechnology sector. The number of biotech deals is the highest it has reached since 2000, and the dollar value is the second highest in history.
During the final phases of bull markets, not only does the number of IPOs rise, but the quality of IPOs deteriorates. The following chart shows that only during the final phases of the internet bubble did we see such a high percentage of money-losing IPOs. Investors are chasing unproven business models.
In the past decade, private equity players have become more important "insiders", and the number of IPOs from private equity backed groups has now reached all-time highs. Furthermore, the follow-on deals from private equity sponsored groups are also at all-time highs. Smart firms were buying companies in the bad times and are now floating them and getting out while they can.
CEOs and managers tend to overpay for share buybacks and for M&A activity with shareholder money. They don't mind sticking it to investors. However, when it comes to their own personal money, they are much shrewder. Insiders consistently sell their own stock when markets are high and buy large quantities of their own stock when markets fall sharply and become cheap.
CREDIT SIGNS OF A TOP: TODAY LOTS OF JUNK DEBT AND VERY LOW QUALITY
In May 2013 Variant Perception wrote a report titled Credit Bubble, Toil and Trouble. We argued that ultra-low interest rates were already leading to a bubble in corporate debt. Investors were issuing large quantities of corporate debt at low spreads. The situation has only got worse since we wrote in our report.
As the following chart shows, in 2013 we saw the highest issuance of junk bonds ever. This was true in absolute numbers and as a percentage of all corporate debt.
Not only is the issuance of junk at record highs, but we have seen the highest LBO transaction volume since 2007. In fact, the market peak in 2007 is the only year where we saw more leveraged buyouts. There is much more in the 28-page report. You can request a copy from the link at the top. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Investigating Spain's Pledge to Lower Taxes (It Won't Happen) Posted: 06 Apr 2014 09:41 PM PDT Prime minister Mariano Rajoy is likely as serious about cutting taxes now as he was in December 2011. Recall that at the start of the 2012 I noted Promises Go Out the Window as Spain Undertakes Huge Tax Increase Coupled With Biggest Budget Cut in History. Via translation from El Economista, the director of the Foundation of Savings Banks (Func), Ángel Laborde says Government is "Not Serious" Regarding a Proposed Tax Cut. Angel Laborde explained in the newspaper El Pais that "government revenues funded only 85% of the costs, excluding financial aid. The remaining 67,755,000, was the deficit had to be financed by increasing debt. This stood at the end of year to 960,640 million, 93.9% of GDP. recall that in 2007 the debt was 36.2% of GDP."
"Despite the widespread belief in our society that public spending is silhouetted sharply, the fact is that in 2013 slightly increased by 0.2% over the previous year. This, coupled with the decline in GDP, made weight representing the same GDP increased from 44% to 44.4%, "says Angel Laborde.
Tax revenues continue to grow by increasing taxes and not by the growth of economic activity, so any tax cut would lead to a reduction in spending or an increase in public deficit. Anti-austerity promises are being made in Spain and France that have virtually no chance of happening. Of course, that is always the expected promise everywhere. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| French Socialists Revolt Against Prime Minister, Threaten Vote of No Confidence Posted: 06 Apr 2014 11:28 AM PDT Further compounding president Francois Hollande's problem with the European Commission Rejection of France's Proposal for Deficit Target Leniency, the socialists are in open revolt against new Prime Minister Manuel Valls. The socialists consider Valls as too pro-business. They want less austerity and a reduction in personal taxes, not corporate taxes. And they are against Hollande's "responsibility pact" proposal that would reduce labor costs and cut government spending. Via translation from Les Echos, please consider Socialist MPs Threaten a Vote of No Confidence on Account of VallsNearly a hundred of Socialist deputies signed a document calling for political change of course and threaten a vote of no confidence in the government on Tuesday. The members of parliament (MPs), groggy out of defeat in local elections, gain momentum to contest the elements of "pact of responsibility."
Jean-Marc Germain, leader of "rebuilders" and very close to the mayor of Lille Martine Aubry, warned Friday that 65 members wanted to get "insurance", including a stronger role for Parliament. Ranks have swelled with the release of a "contract of majority" launched by Pouria Amirshahi among others, Jean-Marc Germain or Laurence Dumont, Vice-President of the Assembly.
This text calls for the Government to consult further their majority and to reorient its policy and that of Europe to fight austerity, investing directly for employment and to favor a "demand shock" through measures favor of purchasing power.
President Francois Hollande promised on Jan. 14 to engage the responsibility of the Government to the pact of responsibility, which includes a reduction of labor costs by 10 billion euros. But the government reshuffle and increasingly hard criticism by the socialist majority have changed the situation.
The absence of policy change line has weighed heavily in the decision environmentalists and casts uncertainty over their vote Tuesday. François Hollande and his government are thus caught between two fires, the majority of which are increasingly demanding the end of austerity and that of the European Commission, for the moment, refuses to France a additional time to achieve its deficit reduction. Demand Shock Spending Spree Not ComingIn light of the EC's rejection of Valls' request for more time to meet deficit reduction targets, it's safe to say a French spending spree is not coming. It will be amusing to see what sleight of hand magic Hollande proposes in his next budget proposal to Brussels. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
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