Equities excess?

June 23, 2017 10:26 AM


The U.S. equities have had quite an upside run since Donald Trump’s somewhat surprising presidential victory in last November’s U.S. general election. The central bank liquidity-driven rally had done very well since former Fed Chair Bernanke took the lead from N.Y. Senator Chuck Schumer’s entreaty to “get to work Mr. Chairman” during Bernanke’s July 2012 Senate economic testimony. That was a reference to the fact the deadlocked Senate was not going to be able to compromise on any economic stimulus legislation. As the Republican House was opposed to the Barack Obama and Democratic Party continued heavy social spending, things were at an impasse.

As such, it was up to the Fed to continue and even expand its massive liquidity infusion quantitative easing (QE) program to prevent a slide back into weakness. The Fed’s action was considered excessive by some in following up on the very much needed post-Crisis March 2009 original QE program and its limited QE2 reinforcing that. Yet expansion into Summer 2012 nominally designated QE3 was considered so expansive by some that they termed it "QE Infinity." This was in part a jest aimed at the Fed Chair having become like a lovable animated feature character, as ‘Buzz Lightyear’ Bernanke took the Fed balance sheet “to infinity and beyond” (a catch phrase from the animated feature Toy Story.)

Equities liked QE

Yet as the opening graph shows, the U.S. equities rather liked the flows that derived from all the additional liquidity not being able to earn any ‘isk-free return with interest rates also being kept down at negligible levels. The S&P 500 generally rallied from down in the 1,300 area after QE3 began in 2012 until it stalled into the 2,100 area by Spring-Summer 2015 prior to some sharp downside reactions. However, even after those reactions ended into early 2016, it still seemed stuck again at generally no better than the 2,100 area prior to the U.S. election. Then there was the Trump election victory, which triggered all manner of positive expectations on various reform and stimulus prospects.

Yet within that context, it is possible to consider U.S. equities might be overpriced now if the Trump agenda does not manage to get passed into law. We have been very pointed in our consideration of the importance of the Trump reform and stimulus agenda as a key determinant of whether the extended U.S. equities rally is indeed reasonable. The operative question is whether they are properly priced at current and ultimately potentially even higher levels. If the Congress can manage to actually pass the Trump/Republican legislative agenda (healthcare and tax reform and infrastructure spending stimulus) into law, there is a real case for attendant acceleration of the U.S. economy. That would, in turn, create the sustained corporate earnings growth that would support current and even higher equities valuations.

Chart source: Barchart.com

Not an imminent warning

However, if not, then the opposite case of equities being overpriced at present (much less at higher levels) is a reasonable concern. And prior to getting into the insights from a very credible source, we need to be clear that this is not some ‘special alert’ on any imminent threat to the current U.S. equities rally. While any correction on the legislative effort failure might be rather substantial, that equities psychology driver will not be apparent until at least later this Summer. Only if the significant legislation in various areas appears to be failing by the time of the U.S. Congress August recess (pretty much the entire month until returning after Labor Day) will things begin to appear direr.

In the meantime, the hope it will succeed along with already constructive Trump rollback of so much of his predecessor’s executive order regulatory regime should provide a very constructive influence. And that positive psychology will reinforce already positive flows into U.S. equities based on technical financial factors (more below.)

As a bit of context for that, when we became suspicious of the U.S. equities bull market at the end of 2006 we also cautioned that the Evolutionary Trend View remained bullish in the near term. At least that’s what we explored in our Capital Markets Observer II-48 “Smooth Rebalancing? …or… The Crash of ’07?” (December 6, 2006.) That was along with considerations on the Fed, U.S. Housing and other factors. The first few pages are the key view on how the equities were indeed already entering a distended bulge that would become a bubble into the higher levels we allowed were likely.

Yet even as weaker U.S. housing indications began to emerge in early 2007, a still very accommodative Fed and the equities’ ability to attract buyers on selloffs had maintained the extension of the uptrend. By June 2007 the front month S&P 500 future had pushed up from March reactions below 1,400 to the mid 1,500 area. That was the point at which we reminded those who were questioning our broader negative view that bubbles could feed on themselves until something came along to burst the extended psychology.

It was at the time we included in our research and even had a blog post the FT’s LEX column was kind enough to publish on why it was still necessary to “Learn to love the bubble.” Much as we are asserting at present, while there can be “various indications the markets are ‘overbought’ (often to the frustration of proponents [that the market is overbought]), some sign they are actualizing that potential requires a failure below technical or psychological price support.”

And as we have focused on for some time regarding the U.S. President getting in the way of his proposed reforms, we suspect the state of the Trump reform and stimulus agenda into late July will be a key overall equities trend influence. As far as any technical price activity failure, it is too early to tell how that pattern might occur later this summer. Back in 2007, it was a mid-July S&P 500 front month future weekly pattern UP Break above 1,550 area that had failed by late month triggering the initial sharp selloff into mid-August.

Trend evolution note

As a further note on the actual overall trend activity, the broad trend in the opening S&P 500 front month future weekly continuation chart had advanced markedly from around the 1,300 area from the time QE3 was instituted. Yet even the renewed bullish tendencies from March 2016 into the November U.S. election were stalled into not much better than the previous highs around the 2,100 area.

As is glaringly apparent, the anticipation of improved economic activity based on Trump reform agenda promises took over the psychology right after November’s U.S. election. That was for the initial late 2016 rally to the 2,270 area, followed by the quasi-euphoric swing up to the 2,400 area into March 1st on Trump administration reform and stimulus announcements prior to some problems creating a reaction.

Yet, right now the classic "Sell in May and go away" seasonal cliché is also obviously not working this year, as the U.S. equities pushed above the previous 2,400-05 March and May front month S&P 500 future highs immediately on June 1. As noted in all recent Market Observations, that has left the interim 2,430-25 area congestion (hit again over the past couple of days) and more prominent 2,405-00 range as key lower supports.


And every time the market holds a near term selloff (just like early 2007), it is even more likely that both the technical and psychological aspects might not become more critical until later on in July (as noted above). Yet there was some further insight on how far in front of reality the U.S. equities might be in a series of CNBC segments on Tuesday.

Those were with Gluskin Sheff Chief Economist and Strategist David Rosenberg. We have been a fan of Rosenberg since he was a kindred spirit on U.S. equities doubts out of 2007 into all of 2008. Like all analysts, he is wrong at times. Yet his insights on the ‘macro’ situation and adherence to respecting it have always been impressive, and prescient at times in opposition to the ‘received wisdom’ of The Street. In the first CNBC segment he mostly asserts that what many feel is a bubble in the bond markets is simply the bonds reflecting the reality of a lower growth path than dictated by upbeat anticipation.

In that we have been on the same page for a while, as we have noted the recent serial weak U.S. economic data well into Q2 that is inconsistent with the anticipation from late last year into early this year. This and all the rest we are about to relate get back to the importance of the success of the Trump reform agenda if the current, and future higher, equities valuations are going to be justified.

In the second CNBC video segment he rebuts the now ‘received wisdom’ future growth estimates from the CNBC host. He cites the New York Fed just having lowered its U.S. Q2 GDP estimate to 1.9% and Q3 down to 1.5%, which he notes a bit later is what used to be referred to as “stall speed” rather than the 3.0+% the Trump administration is projecting.

When asked about other respected individuals saying things are good, he asks what their definition of good might be? He cites U.S. Housing Starts and automobile sales both down for the past five months, and restaurant sales (which is a bellwether for Consumer Discretionary Spending) being down for each of the last four months. Of the major 16 major economic indicators released in the past five weeks, only one managed to come in above estimate.

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About the Author

Alan Rohrbach is Lead Analyst and President of Rohr International, Inc.  He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.