There’s one holiday you may have missed in the festive season just passed: December 11, when the Fed released its quarterly Z.1 report.
It was a sort of Christmas for finance nerds like me. The Z.1 is a treasure trove of macroeconomic data for the United States. Want to know if households are getting richer or poorer? Or if people are saving more? Z.1 has the answers.
At 175 pages, the Z.1 is a monster. So I’m happy to have Jesse Felder, editor of The Felder Report, join us today to distill some of its most important data down into useful stock market indicators.
Jesse is a new contributor to this space, but I’ve been following his work for a while. As you’ll read, he does the kind of data-driven, fact-focused analysis that we at Casey Research love. Jesse has been managing money for over 20 years, having worked for Bear Stearns and then cofounded a multibillion-dollar hedge fund. Today he runs a family office.
Read on for Jesse’s take on what the new Z.1 data are telling us about the US stock market.
Managing Editor of The Casey Report
Everything but the US Stock Market Has Already Peaked
The new Z.1 report came out today, so let’s update many of the indicators I’ve been sharing over the past few months. What should be worrisome to market watchers here is that we now have a host of significant indicators that look like they may have formed important peaks and begun to roll over. We will need to see at least a couple more quarters’ worth of data to be sure, but this is certainly something to keep an eye on.
First let’s take a peek at Warren Buffett’s favorite valuation yardstick. (See “How to Time the Market Like Warren Buffett” for a look at one way I use this indicator.) It actually peaked last quarter and saw a small retracement in Q3. This indicator is 83% negatively correlated with future 10-year returns in stocks (the higher the reading, the lower forward returns), and its current reading implies a -0.88% annual rate of return over the coming decade. The 10-year Treasury at 2.2% looks fairly attractive in comparison.
Next we can look at the household percentage of financial assets allocated to equities. This indicator is even more negatively correlated to future 10-year returns, at about 90%. It has also pulled back just a bit from the peak it made in Q2. Its current reading implies a forward return of about 2.8% per year over the coming decade, slightly better than the 10-year Treasury.
Finally, comparing the current level of the S&P 500 to its long-term regression trend, we can see that the only other time in history stocks were this overbought was at the height of the Internet bubble. This measure is 74% correlated to future returns—not as high as the first two indicators, but not bad, either. It also looks at the largest data sample of the three, so I believe it’s worth including. Its current reading suggests stocks should return just 0.74% per year over the coming decade.
Blending the three forecasts together, we get a 0.89% annual return forecast for the stock market over the coming decade. A straight comparison to 10-year Treasuries yielding 2.2% shows them to be more attractive right now. Hell, even 5-year Treasuries are paying 1.6%, nearly double our model’s forecast. All in all, this looks to be the second-worst time to own equities in history.
Still, the stock market’s uptrend remains intact, as all of the major indexes currently trade above their 200-day moving averages. But as I’ve noted recently, there are plenty of signs that the trend is not as healthy as bulls would hope. The advance/decline line, new highs/new lows, and the percentage of stocks trading above their 200-day moving averages are all diverging fairly dramatically from the new highs recently set by the indexes. These are serious red flags.
And now that our market cap-to-GDP and household equities indicators have possibly peaked—along with high-yield spreads (inverted), margin debt, and corporate profit margins—there seems to be a very good possibility that the uptrend could be tested in short order. In fact, I went back and looked at the instances when these three indicators peaked around the same time during the past 15 years or so, and I found that they coincided pretty neatly with the major stock market peaks:
|Stock Market Peak||Q1-2000||Q4-2007||???|
|Market Cap-GDP Peak||Q1-2000||Q4-2007||Q2-2014|
|Household Equities Peak||Q1-2000||Q2-2007||Q2-2014|
|Margin Debt Peak||Q1-2000||Q3-2007||Q2-2014|
|High-Yield Spreads Peak (Inv)||Q3-1997||Q2-2007||Q2-2014|
|Corporate Profit Margins Peak||Q3-1997||Q4-2006||Q3-2013|
So the uptrend may still be intact, but I think we have a plethora (yes, a plethora) of evidence that suggests its days may be numbered. Foreign equities have mostly given up their uptrends over the past few months, and commodities, led by the oil crash, look even uglier. How much longer can the US stock market swim against the tide?