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Why The U.S. Stock Market Never Completely Recovered

Clearly, the global economic slowdown remains a headwind for U.S. stocks. The same canaries in the investment mines that stopped serenading last summer are straining their vocal chords once again. In sum, the S&P 500 has never fully recovered because global economic headwinds, equity overvaluation and anemic market breadth remain. Some things go unnoticed. For example, the S&P 500 rallied 13% off its closing lows (1867) set in late August. Lost in the shuffle? The popular benchmark has yet to revisit its closing highs (2130) registered back in May. In essence, the corrective activity that began in the springtime as a function of a faltering global economy, overvalued equities and weakening market internals has yet to run its course. What’s more, these factors that led to the August-September sell-off in risk assets are unlikely to dissipate quickly. Let’s start with the macro-economic backdrop. Data show that quantitative easing (QE) in Europe is not stimulating borrowing activity the way that it stimulated borrowing activity in the United States. If European consumers and European businesses are fearful to take out loans – or if creditors are unwilling to extend credit – the euro-zone economy is unlikely to show improvement. Similarly, European stocks would not experience much of a boost from share buybacks. Not surprisingly, then, the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) failed to rise above its 200-day moving average; it never came close to recapturing its 52-week high. At this moment, the euro-zone proxy is still 12% below its high-water mark. Europe is hardly the only canker sore on the world stage. Japan recently revised its economic growth projections lower. China is slowing dramatically. And nations that depend upon natural resources exports (e.g., Australia, Canada, Brazil, Chile, etc.) are witnessing yet another downturn in commodity prices. In fact, the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ) has plummeted back to levels not seen since the late August free-fall for U.S. stocks. The bullish case for U.S. stocks continues to rely on the notion that the rest of the world does not matter. Ironically, the Federal Reserve did not raise borrowing costs in September and cast doubt on any rate hike this year when it stated that “…global economic and financial developments may restrain economic activity.” The central bank subsequently backtracked at its October meeting by removing its commentary on global issues altogether. So do the economic hardships abroad matter or not? They matter with respect to corporate earnings and revenue. Consider the reality that corporate profits as well as sales were negative for the recent quarter (Q3) and that multinationals with greater overseas exposure witnessed steeper year-over-year declines. Clearly, the global economic slowdown remains a headwind for U.S. stocks. What’s more, declining earnings and declining revenue continue to pressure U.S. stock valuations . We are now looking at a price-to-sales ratio of 1.84 – one of the highest P/S ratios on record. The third component that sent stocks tumbling back in August was the softening of market internals . In particular, the discrepancy between the S&P 500’s Advance-Decline (A/D) Line and that of the New York Stock Exchange (NYSE) pointed to fewer and fewer large companies holding up the benchmark. Here in November, the disparity appears to have resurfaced. Some researchers have been particularly outspoken on the lack of market breadth. Heading into the current week of trading, Strategas Research Partners noted that ” the 10 largest stocks in the S&P 500 have contributed more than 100% of the year’s roughly 2% gain .” They added that ” the 10 biggest stocks in the index accounted for just 19% of the gains last year and 15.2% of the index’s return in 2013 .” We should let the above data sink in for a moment. In 2013 as well as 2014, the S&P 500’s appreciation was attributable to most of its components. In 2015? Only the 10 biggest large-caps account for the positive spin. It gets worse. The same canaries in the investment mines that stopped serenading last summer – high yield junk bonds, emerging market stocks, small company stocks, commodities – are straining their vocal chords once again. The iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) appears destined to retest its 52-week lows in the same way that commodities via DBC have. In sum, the S&P 500 has never fully recovered because global economic headwinds, equity overvaluation and anemic market breadth remain. Transporters, industrials, energy, materials, retail, leisure, household products, utilities, real estate, media, healthcare – a wide variety of sectors and sub-sectors have been buckling. It follows that it should not be all that surprising to see the S&P 500 buckle as well. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

What Deleveraging May Mean For Netflix And Many Of Your Favorite Stocks

One way or another, debt extremes eventually give way to deleveraging. The exact forces that push a high-flyer to incredible heights can send it plummeting 20,000 leagues beneath sea level. And while it is certainly possible that the Fed can deftly maneuver in the near-term, longer-term investors need to be more vigilant. You know those annoying notifications that chime on your cell phone in the middle of the work day? The ones that sound off to let you know when Kim Kardashian’s daughter sits on a commode? Or when Donald Trump insults a member of the media? I get far too many of those. I’ve tried playing with the notification settings on the apps on my iPhone, but somehow, I still get a ton of unwanted messages. Last week, I received a Yahoo Finance notification shortly after the stock market closed shop. The one-liner? “Stocks soar on judgment that Fed will delay rate hike.” Let that sink in for a moment. Stocks are not rocketing because investors are confident about corporate profitability or sales. They’re not climbing due to jobs optimism or economic acceleration. The Dow moved higher for seven consecutive trading sessions (through Monday 10/12) because – in spite of seven years of 0% overnight lending rates – the U.S. economy is still too weak for a token tightening gesture. No doubt about it. This is not the 80s or the 90s anymore. Years ago, money managers, institutional traders and the overall investment community owned stock assets because public corporations were likely to grow their businesses in a strong U.S. expansion. Now? Investors own equities because the “no-go” economy still requires unimaginably cheap credit. So what’s the big deal about leaving interest rates so low for so long? One reason is excess speculation. For example, plenty of folks own Netflix (NASDAQ: NFLX ) and they have enjoyed a number of years of extraordinary price gains. More recently, however, folks have leveraged account values in order to own even more shares of NFLX. Just as homeowners in 2005 used cash-out refinancing to acquire additional properties with negligible down payments, NFLX shareholders have used rising account values in margin accounts to buy more NFLX stock. As shares of the media giant rise – as NFLX begins looking like a no-lose proposition – speculators employ more leverage to acquire even more shares of NFLX. And why the heck wouldn’t you borrow to buy more? The Fed’s going to make sure that stocks won’t fall, right? Borrowing money for the purpose of leveraging a stock position is known as margin debt . It has been a profitable venture for anyone who arrived early at the reflated asset price party. Of course, parties eventually end. Those who overstay their welcome or who arrive late will will find themselves nursing monstrous losses. Consider the fact that NYSE margin debt cracked at an all-time high near the $500 billion mark in April. By September, margin debt sank 6.7%, down to $473 billion. Why might this matter? There have only been four times since the turn of the century when margin debt pulled back by 6.7% or more – April 2000, August 2007, May 2010 and August 2011. Those are some relatively inauspicious dates. Granted, 2010 turned out to be a short-lived correction in the early stages of the current bull market. The other three occasions – the dot-come tech wreck, the worldwide financial collapse and the euro-zone crisis – resulted in massive drawdowns for world stock benchmarks. Margin debt deterioration is, of course, deleveraging within the stock market. Not only does it signal a lack of confidence that the borrowing-to-buy game can continue indefinitely, but significant declines in markets themselves trigger margin calls that, ultimately, force the sale of the underlying assets. Now let’s revisit shares of Netflix. Margin debt is a function of the underlying “collateral.” Forced liquidation subsequently reduces the value of the collateral (NFLX) which triggers still more margin calls and additional liquidation. The exact forces that push a high-flyer to incredible heights can send it plummeting 20,000 leagues beneath sea level. (Note: My intent is not to pick on Netflix; rather, I am highlighting how leverage often destroys the best laid plans.) How enthusiastic have speculators been relative to actual economic activity here in the fall of 2015? Margin debt as a percentage of GDP is close to 3%; in the fall of 2000 and in the fall of 2007, margin debt-to-GDP hit 2.4% and 2.3% respectively. And it’s not just margin debt that suggests leverage is hitting obscene levels. According to recent research conducted by McKinsey, total debt (consumer, business, government, financial) as a percentage of GDP has surpassed the extremes of 2007: 286% versus 269%. $57 trillion of fresh debt across 7 years at a rate of 5.3%, far outpacing the 2.2% growth in GDP. As my daughter might inquire, “Who’s gonna pay for that?” Optimists say that when consumers use their credit cards at H&M, when drivers take out auto loans for Audis, when students acquire loans for their $40,000-per-year education, the activity shows confidence in the future. And after all, they tell us, the ability to service the debt is all that matters. On the other hand, if debt is expanding at a faster rate than economic activity, will the day not come when the expansion of that debt surpasses the ability to service it? If consumer credit as a percentage of GDP was insanely high at 17.5% leading into the financial meltdown circa 2007, how are people better off when it is at 19.5%? Or should we simply assume the Federal Reserve will be able to keep borrowing costs near historic lows forever? Debt cannot increase indefinitely. Like an economy itself, expansion gives way to contraction. There are credit cycles just as sure as their are business cycles. We should not be surprised, then, that the Bank of International Settlements (BIS), the International Monetary Fund (NYSE: IMF ) and the German finance minister have all warned about extremely high debt ratios the world over. Each have used terms like “dangerous over-leveraging” and “credit panic,” while simultaneously fretting a global financial system that would be vulnerable to any amount of monetary tightening by the U.S. Federal Reserve. Can you say, “Catch 22?” One way or another, debt extremes eventually give way to deleveraging. And while it is certainly possible that the Fed can deftly maneuver in the near-term – prompting the federal government as well as American businesses, consumers and market speculators to keep borrowing freely – longer-term investors need to be more vigilant. In essence, one’s equity component should focus on low volatility and quality at this juncture. Consider the iShares MSCI USA Quality Factor ETF (NYSEARCA: QUAL ) and/or the iShares USA Minimum Volatility ETF (NYSEARCA: USMV ). If you’re going to own individual securities, even in a downturn, you will want to think in terms of low leverage companies like Costco (NASDAQ: COST ) and low volatile corporations like PepsiCo (NYSE: PEP ). What’s more, you may want to resist the temptation in thinking that the worst is over for previous momentum standouts like the SPDR Biotech ETF (NYSEARCA: XBI ). Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Stock Investors Bask In The Economic Slowdown’s Glow

Once more, the U.S. economy is flirting with trouble. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. The financial markets will only support extreme overvaluation if the Fed is in “stimulus” mode, as opposed to “de facto” tightening. By July of 2012, a wide range of indicators suggested that the U.S. economy was flirting with trouble. Job growth was decelerating. Business investment was deteriorating. Meanwhile, manufacturing via the ISM Manufacturing Survey (PMI) was flirting with contraction. Up until that moment in time, the Federal Reserve had already left rates at zero percent for three-and-a-half years. What’s more, they had already created trillions of electronic dollars to acquire government debts and push borrowing costs to unfathomable lows to ward off a double-dip recession (i.e., “QE1,” “QE2,” “Operation Twist”). However, the end of those programs seemed to show that the U.S.economy was still too fragile to stand on its own. Not surprisingly, leaked rumors about a more awe-inspiring economic jolt began taking over the July 2012 business headlines. Terms like “QE3, “QE Forever,” and “QE Infinity” had been making the rounds. Indeed, by September of 2012, The Fed had unleashed an open-ended bond buying program that rivaled anything investors had seen previously. Fast forward three years. Once more, the U.S. economy is flirting with trouble. The percentage of 25-54 year-olds (19.5%) that are out of work has risen sharply. (Retirees? College students?) Median household income is sagging. Business investment in research, plants, equipment and human resources development is virtually non-existent, with virtually all after-tax profits going to share buybacks and shareholder dividends. Non-revolving consumer credit has grown from 14.6 percent of after-tax income at the end of the recession (6/2009) to 18.7 percent (6/2015). And manufacturing via PMI? Falling throughout 2015 and hanging on by a thread (50.2), we’re right back to the type of environment that prompted previous calls for more quantitative easing (QE) “cowbell .” From an investment standpoint, the demand for U.S. treasury bonds in recent government auctions still points to risk aversion. Recall Monday’s 3-month T-Bill auction (10/5) where $21 billion had been acquired at 0%. Zero percent! It was the lowest yield for the 3-month T-bill on record . On Wednesday (10/7), another $21 billion went to auction on 10-year Treasury bonds. The high yield of 2.066% was the lowest since April. Equally worthy of note (no pun intended), the indirect bidding component that includes significant central banks acquired $13.1 billion (62.2%) – the second highest percentage on the record books. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. For instance, the New York Stock Exchange (A/D) Line shows September’s successful retest of the August lows. Remember, it was the A/D Line that foreshadowed the dramatic sell-off in the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) before its mid-August arrival. Higher lows and higher highs on the A/D Line from here forward would likely signal a shift in attitude toward greater risk taking. Another trend that is worth watching? Consider the relationship between U.S. treasuries and crossover corporates – U.S. company bonds that straddle the line between low-end investment grade (Baa) and higher-rated “junk” (Ba). A rising price ratio for iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) : iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) is a sign a of risk aversion. Granted, IEF:QLTB is still rising alongside its 50-day trendline. On the other hand, the fact that IEF:QLTB is lower than it was in August may be a sign that risk taking is on its way back. Put another way, a tightening in spreads between treasuries and crossover corporates would be a sign that investors might be looking for a return on capital again, rather than a return if capital alone. Indeed, the battle between risk-on and risk-off has reached a crossroad. Many of the significant stock ETF proxies – the SPDR S&P 500 Trust ETF ( SPY ), the iShares Russell 2000 ETF (NYSEARCA: IWM ), the V anguard FTSE All-World ex-U.S. ETF (NYSEARCA: VEU ), Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ) rest near resistance levels of 50-day moving averages. Similarly, the S&P 500 itself fights to reclaim the psychological level of 2000, while the Dow Industrials toils to climb back above a psychological level of 17,000. Keep in mind, though, analysts widely anticipate earnings and revenue declines for the third consecutive quarter . If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. And if recent history is any guide on investor comfort will overvalued equity valuations, investors would not take kindly to a 4th quarter rate hike campaign; that is, the financial markets tens to support extreme overvaluation when the Fed is in “stimulus” mode. A three-month stock celebration (Oct-Dec) may come down to these factors: (1) the Fed stays at the zero-bound, (2) the 10-year stays at 2%-2.25% to keep the credit bubble blowing, and (3) the earnings and revenue picture surprises at the flat-line, as opposed to disappointing with sharper than projected deterioration. In the meantime, pay attention to the market internals via the A/D Line as well as the spreads between treasuries and corporates. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.