This Stock Market Rally Is Going To Fall Apart

roller coaster2My Comments: Another brick in the pile that says we’re headed for a market correction. A major clue is called the price to earnings ratio or P/E. It’s a readily available metric that helps understand relative valuations. The Shiller CAPE ratio is today recognized as the better measurement of market valuations. Currently, it is almost 63% higher that it’s historic mean. That comes back to a statistical law called reversion to the mean. What goes up also goes down.

Bob Bryan Aug. 4, 2016

A common refrain around the markets and economy is that expansions don’t die of old age. But that doesn’t mean they can’t still get a bit weary.

The recent run-up in stocks to an all-time high comes in the eighth year of the current bull market, making it the second-longest such market in history. Given the bull market’s “old age,” this recent upswing isn’t going to last very long, according to Jonathan Glionna at Barclays.

Glionna, head of US equity strategy research, argued in a note to clients on Wednesday that while the recent stock surge has come on the back of strong economic data, it is not enough to push the market higher over the long term.

The strategist came to this conclusion by analyzing three previous late-stage rallies since 1980 — 1988 to 1989, 1998 to 1999, and 2006 to 2007 — and identifying three conditions that are needed to make them sustainable. They are:
1. Increasing profit margins. Profit margins in each of the past three late-stage rallies hit new cycle highs in order to sustain the rally. This time around, margins have been on the decline since the third quarter of 2014, and even with a recent bounce in aggregate profits, a new cycle high seems unlikely.
2. Growing dividends. In each of the past three occurrences, dividends from S&P 500 companies have been increasing at a rapid pace. “Fast and accelerating dividend growth was present throughout each of the last three prolonged late-cycle rallies,” Glionna wrote. “But, dividend growth has begun to slow. We project a 6% increase in dividends for the S&P 500 in 2016. This is the lowest growth rate since 2010.” Additionally, forecasted growth for the next year is just 4.5%, showing a clear slowing pattern.
3. Increasing leverage. This one is happening, according to Glionna, but it may not have much more room to grow. “While this may be a sustainable amount given the easy conditions and low rates in high grade credit, the days of accelerating growth in borrowings are likely in the past, in our view,” Glionna wrote.

“This is because some important measures of debt sustainability, such as the ratio of debt-to-EBITDA are already elevated.” Essentially, companies are running out of room to borrow more.

Each of these three trends is a sign that companies could continue to grow more in the future. Since the stock market is essentially an investment on future expected growth and earnings, then higher profits, income from dividends, or growth through leverage would inspire investor confidence.

With each of these trending in the wrong direction, investors are less likely to assume that the future of a company is going to be brighter, which in turn means the stock price is less likely to increase. Thus, investors stay out of the market, and there goes the rally.

As we have mentioned before, it’s fair to point out that past cycles may not necessarily be predictive of the current one, and a lot has changed in the markets and economy since the financial crisis.

However, past occurrences are many times all we have to predict future events. And right now, the past isn’t saying anything good.

The source article can be found HERE.