Don’t mistake my positive explanation of the BLS, ADP, and ISM reports to indicate that I’m bullish on stocks for the long-term. Unlike the typical commentator who claims he/she is expecting a correction in the short term, but is bullish for the long term, I claim that I don’t know where the market is headed in the short term, but I’m very bearish on stocks for the long term. It’s rare to find a prognosticator who is bearish on stocks in the long term. However, based on historical performance, sometimes being bearish on stocks over the next 10 years has proven to be an accurate prediction. As someone who focuses on valuation, even I have questioned this strategy because of the time the market has spent in its mature phase. The S&P 500 is up about 9% since I went bearish in December of 2015. It’s reasonable to wonder how much potential profits you are willing to leave on the table to avoid a 40%-50% correction. My counter point to this argument is that most cycles have corrected earlier than this one. If you get too aggressive, you raise the risk that you’ll catch the 40%-50% decline you’re trying to avoid.
There seems to be a bull market in unique valuation metrics to describe the current bubble. That makes sense because there isn’t much interest in valuations when they are near historical norms. Now that they are stretched, there is demand for these charts to watch in awe how historic this rally has been. The chart below is one more example of a unique valuation metric which screams now is a time to avoid stocks. It shows the number of hours of work needed to buy the S&P 500 using the average hourly earnings. This shows two things. It shows how expensive stocks have gotten and it shows have the average worker hasn’t participated in the expansion. This is why the Rust Belt states voted against the incumbent party in America.
The six charts below review the 1 month rolling asset allocation of global macro hedge funds. The expressions of a long S&P 500, long Nasdaq, and long U.S. dollar position are all in the crowded stage. Some investors who are trying to gain context as to when the cycle will end look towards these sentiment indicators. It’s certainly a valuable tool, but at this point, the market has blown past many of the traditional signals which have worked in the past. The expansion of the central banks’ balance sheets are the principal cause of this.
In the ADP report, large businesses with 500 or more employees hired 83,000 new workers. Deutsche Bank has differing metrics. As you can see in the chart below, the year over year employment growth in S&P 500 companies has gone negative. In the last cycle, it first went negative in 2006. This was right before the labor cycle peaked and about 2 years before the market crashed. The labor market has already peaked this cycle, but it has plateaued instead of having a rounded top like last cycle.
I like to look at the establishment employment reports to give potential context for when this situation can reverse. While stocks should fall on their own weight, I think there’s a higher chance of a fall when the most visible reports start to weaken. That’s why I’m not anticipating an imminent crash. As I mentioned in the article about the ADP report, small business employment is more important than large and medium sized businesses because it represents about 2/3rds of new job growth. Therefore, I was slightly concerned by the chart below which shows the largest businesses accelerating past the smallest businesses. The Deutsche Bank report counteracts that concern. The potential difference in these metrics may either be in the way the data is collected or a discrepancy in the amount of businesses which have over 1,000 employees, but aren’t in the S&P 500. I don’t think these companies are doing disproportionately well enough to make up for the discrepancy.
While the price of oil did fall 1.5% today, it is still at $53. I have been expecting oil prices to fall for a few weeks; it hasn’t happened yet. As a reminder, I expect energy prices to fall which will hurt energy stocks’ earnings. Because energy is expected to have an outsized effect on earnings growth in 2017, this is significant enough to cause the stock market to fall. The main reason why I am bearish on oil prices is because of the extreme speculation on the long side by fund managers. I have mentioned the possibility that these trades would unwind without oil prices falling. The exact reverse of that ended up happening as the speculation has gotten larger and the price hasn’t gone up much. The fact that net long speculation in WTI futures increased 3.1% to record highs and the price didn’t increase signals to me that a reversal is near. This amped up speculation makes me more confident that when the trade does unwind, the price of crude oil will fall. It’s important to highlight that while the trade can last a few more months, it is inevitable that it will reverse itself. Traders will not be bullish on oil forever.
Conclusion
It’s clear that the market is overvalued and that fund managers are extremely bullish on stocks and oil. They’re also bullish on the dollar which is strange because today the strong dollar was the reason why oil fell. When I review the negative hiring metrics from Deutsche Bank which says that the S&P 500’s year over year employment growth is negative, I am not making the point that the current labor market is weak. I am using it as a potential leading indicator to figure out when the establishment reports will go negative. Weak economic reports are the catalyst I see which could knock the market lower. Judging by their strength, I don’t see an imminent stock market crash. I remain negative on stocks for the long term.
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