Custer’s Last Stand and the Stock Market today

    Most of us know the story of Colonel George Custer’s 7^th Cavalry and how they were crushed by the alliance of Lakota Sioux, Cheyenne and Arapaho tribes led by Crazy Horse and Sitting Bull. Historians have said that Colonel Custer was warned several times of the size of the Indian alliance.  He had six Crow scouts, Whiteman Runs Him, Curley, Hairy Moccasin, Goes Ahead, Half Yellow Face and White Swan who warned Colonel Custer, but he paid little attention.

The “scout indicators” that we are listing here suggest overall caution in the stock market is warranted. We are not suggesting to indiscriminately dump shares but rather to consider taking money off the table and await  much better buying opportunities later after or during a decline. It could be very severe so look for and await “sales” on stocks that you find as undervalued.  More than ever at these high valuation levels, one should insist on value. Above all, make sure that you read the conclusion that attempts to put all this together.

                                 The “vacuum” level under the stock market …                                                       

A “vacuum” you may ask; it is a way of describing the fact that far too many shares have been bought at the high end of their valuation levels- the high end of their three year price ranges. This creates a weak support for the market if a serious down move commences.  There will be a complete lack of support buying which will send many stocks on a downward slide. In essence, too many stocks have been bought at high prices above their historical proper valuation levels. They will return at least to their historical proper valuation levels. There will be no support at that high valuation levels in our view during a major decline.

Keep in mind that in the markets today there is VERY LIMITED LIQUIDITY in many if not most publicly traded stocks. During a major move down in the stock market, finding buyers for shares may prove quite difficult without the enticement of brutal declines before buyers bring in needed support. Today’s narrow spreads have destroyed the needed support of the past.

             But for 3 years we have projected a 20% to 25% correction and we were wrong!  

       We like to see cyclical declines of 20% as they allow the funds that must invest weekly and monthly the opportunities to invest at reasonable price levels or better yet when their stock picks are undervalued and “on sale.” If stocks in their portfolio’s universe of stocks are overvalued, they still must invest.  You may ask as to why large volumes of some stocks are bought at such high prices. The answer is that some institutions and mutual funds (but not all) generally must invest as they are not permitted to hold large cash positions. They must invest despite high valuation levels. Very often they are restricted from investing in many stocks that may be totally undervalued.

                                    Gross Domestic Product (GDP) to the Value of US stocks…      

  The United States Gross Domestic Product “GDP” is currently at approximately $17 trillion. The value of all stocks traded in the U.S. is currently between $21 Trillion and $23 Trillion. Again, some say it is closer to $23 Trillion; however there is some duplication so I will use the lower range of $21 trillion. Using the lower number gives us a market value of stocks equal to 124% of GDP. It has been at this level only twice in the last 100 years. At the 1999-2001 market top, the ratio hit 168%.    

  However at that time the NASDAQ had a ludicrous value of $6.7 trillion which pushed the overall Stock Market to GDP level up to the 168% level. Today the NASDAQ is carrying a value of $8.5 trillion! So it is approximately 50% of GDP! And that is just the NASDAQ!  The value of the S&P 500 stocks which represent 70% of all US stock values are now at percentage levels to GDP that they were at in 1999-2001 which led to a 50% market decline.  

                             Stock Market’s “Price to Sales Ratio”…..its highest level ever…                         

   This is an important indicator that few investors are familiar with and is now in dangerous territory, in the past these levels have led to long bear markets. The value of all U.S. stocks is now at over two times the gross sales of the companies. Oddly similar, this is now at about 30% over the normal level and at its highest level ever. That is quite high for the overall stock market. Historically, the price to sales ratio has been between 1.3 tines to 1.7 times.

                 The Insiders (officers and directors) are selling at near the highest rate ever…

Insiders (officers and directors) are very heavy sellers, a bad sign. Last week, in a one week period insiders bought approximately $41 million of their own companies’ shares, that same week, the most informed of all investors sold $499,000,000 of their own companies’ shares. It was one of the largest dollar values of insider sales that we have ever seen. The prior week, they sold approximately $497,000,000 of their own companies’ shares.  This amounts to a huge dollar amount that has been rarely ever seen in the past.

                                                     It’s been a long running stretch…

We are now at the longest time period between 20% corrections that we have ever seen. The average is 635 days. We are currently at over 1500 days. Too many stocks have been bought at high valuation levels. That is not good at all as high valuations cannot be sustained in bear markets. We believe this has been supported by the intervention of the central banks that see the absolute necessity to keep the stock market up as it is a vital ingredient in the economy and the perception of the economy.                                                                                 

                                               And as for the market’s “Cycles”…

If you study cyclical analysis and delve into the cycles, it sends a pretty strong message, that message is “heaven help us!” We have too many cycles both long term and short term that simultaneously are projecting a harsh bear market that is supposed to commence very soon. The problem is that the current cycles are occurring at the same time with valuations that we have listed here that always have led to harsh bear markets.

One must understand that no scheduled cycle must occur, if it does not occur it is termed a “cyclical inversion.”  However, we must emphasize that too many cycles are occurring right in front of us that spell trouble for the stock market for years. However the cycles project higher prices for commodities such as gold and oil.     

                                                               Our Conclusion…  

It doesn’t make sense but bull markets do not end due to overvaluation. They generally end with interest rates rising more than moderately, a decline in the money supply or a recession which we don’t yet have. Moreover, we now have short and long term cycles that are issuing strong warnings. Take a look at the past and note the similarities with the market today. Dangerous market tops are usually accompanied by overvaluation. Caution is warranted.

                                                     THE KEY MAY BE THE U.S. DOLLAR…                                               Three weeks ago I sent out charts to clients that suggested that the Dollar was finishing a top based upon seven technical and cyclical indicators. We still believe that is correct and what readers should consider is that commodities run contra the U.S. Dollar. If the Dollar is up, commodities are weak. If the dollar is weak, commodities are strong.

We are suggesting that if the dollar is making an important top, that is a signal that the commodities markets are completing their price bottoms. Commodity bull markets are a major negative for the industrial stock market such as the S&P 500 and Dow Jones Industrials. However, it is a major positive for mining stocks and for a major segment of the Canadian economy-mining!

Thank you, Bob Pellerin and K.C. Grainger