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2014 was the best of times and the worst of times in financial markets. Stocks rallied, of course, while bond yields and commodity prices plunged. In 2014, the S&P 500 gained 13% while the yield on 10-year Treasuries dropped from 3.03% to 2.17%, and the price of oil collapsed by 50%.
And the all-important U.S. dollar rallied as other major currencies such as the euro and the yen plunged. Investors looking for a consistent message from markets had to look elsewhere.
In January 2015, a similar theme spooled out in a completely different way…
The S&P 500 lost 3% – its worst performance in a year – while Treasuries had their best month in five years, as interest rates plunged to record lows around the world. In fact, yields on government bonds in many places are negative, a profoundly unhealthy phenomenon.
Crude oil dropped for the 7th month in a row, something it did during the 2008/9 financial crisis, even after a manic rally on Friday, January 30. The U.S. dollar continued to rally for the 7th month in a row and had its best month since May 2012.
Here's what January's action means for the rest of 2015…
Pundits like to talk about the "January indicator" which, according to the Stock Trader's Almanac, holds that, as January goes, so goes the year 89% of the time from 1950 to 2013. Of course, that rule didn't hold in 7 of those years, this is the third year of a Presidential election cycle (when the market usually goes up), and on the other side of the ledger the S&P 500 has never rallied 7 years in a row (2015 would be the 7th consecutive year of gains).
In other words, basing one's investments on these types of statistics is a fool's gambit. What an investor needs to do it look at the facts.
And the facts are grim. Stocks are trading at extremely high valuations against a backdrop of slowing economic growth and rising global financial and geopolitical instability. And bond markets are sending truly alarming signals about the state of the global economy.
A Look Through the "Buffet Goggles"
Let's start with stock valuations. Warren Buffett's favorite valuation measure, the ratio between the total value of all S&P 500 companies and U.S. GDP, is currently at twice its historical average. The Shiller Cyclically Adjusted P/E Ratio, which measure stock values over a rolling 10-year period, is at 1.7x its historical average.
And the forward price/earnings ratio of the S&P 500, which is based on reported earnings that are artificially inflated by many factors (most importantly massive stock buybacks funded with low cost debt), is currently 16x versus an historical average of 14x (and therefore, because earnings are artificially inflated, less overstated than it is). In other words, stocks are very expensive.
An Alarming Number of Bonds Are Sporting Negative Yields
Now let's look at bonds. Ten-year Treasuries are now yielding 1.67% and the iShares 20+ Year Treasury Bond ETF (TLT) returned 9.8% in January. As crazy as it seems, this ETF is still something to buy because the 10-year yield is likely heading below 1.50% and could easily trade in the 1.0% to 1.25% range. The 30-year Treasury yield is trading at a record low of 2.22% and is likely heading under 2.0%.
The scary thing is that U.S. interest rates are still much higher than the rest of the world. Five year German bunds – the European benchmark – are negative and some $3.6 trillion of government bonds around the world are now sporting negative yields.
Investors should make no mistake about it: this is profoundly abnormal, unhealthy, and unsustainable, and a sign that something is seriously wrong with the global economy. And for that reason, it is a big mistake to think that stocks can continue to rise in such an environment.
For that reason, I recommend that investors should buy ProShares Short S&P 500 ETF (NYSEArca:SH) shares. This will rise if the stock market falls, which I expect it to do soon.
The Millstone Holding Down Global Growth
Next, let's look at global financial stability – or instability. The world is currently home to more than $100 trillion of debt. The problem is that the global economy can't generate enough income to pay the interest on this debt or pay it back.
Why is that? Because the money that was borrowed wasn't invested in the types of productive assets that generate income such as new businesses, new technologies, and innovation.
Sure, some of the money was invested in those things, but not nearly enough. Instead, most of the money was invested in non-productive assets such as housing and consumption. As a result, the world was left with too much debt and too little ability to handle it.
All of this debt is making it increasingly difficult for economies to grow. This is why the recovery from the financial crisis has been one of the most disappointing on record. And after several quarters of reasonably impressive growth, the U.S. – the only country in the world that is showing any strength – is stumbling again.
Last week, we learned that gross domestic profit only grew at 2.6% in the fourth quarter of 2014, roughly half the pace over the summer (which was itself overstated by statistical anomalies). For all of 2014, GDP only grew at an average rate of 2.4%, nothing to write home about. While consumer spending was strong in the fourth quarter, businesses pulled back.
First-quarter 2015 growth is also looking sluggish. The truth is that it is very difficult for heavily indebted economies to grow quickly and the U.S. economy is heavily indebted in both the public and private sector. Add the crushing weight of over-regulation, taxes, and Obamacare and you have a structural problem that can only be addressed through policy changes.
Geopolitics Are Playing an Corrosive Role
Finally, let's turn to geopolitics. Russia has increased its aggression in the Ukraine in the face of seeing its economy crumble as a result of the oil price collapse. This poses a direct threat to europe that can only be ignored for so long. The Middle East remains a powder keg.
China continues to advance its interests in the South China Sea and elsewhere. A rare bright spot was President Obama's visit to India last week, but overall global instability is rising and poses a threat to markets.
Against that backdrop, therefore, nobody should be surprised that stocks fared poorly in January. The real surprise is that they did so well in 2014.
Last week was particularly ugly with the Dow Jones Industrial Average (INDEXDJX:.DJI) losing more than 500 points or 2.9% to close at 17,165.95 while the S&P 500 (INDEXSP:.INX) dropped 57 points or 2.8%. The Nasdaq Composite (INDEXNASDAQ:.IXIC) index shed 123 points, or 2.5%, to 4635.24. A number of large companies such as Microsoft Corp. (Nasdaq:MSFT), Procter and Gamble Co. (NYSE: PG), Pfizer Inc. (NYSE: PFE) reported earnings that were hurt by the effects of the strong dollar.
This is a trend that will continue as 33% of S&P 500 earnings come from outside the U.S. Energy companies are also reporting lousy results, which should come as no surprise. Energy giant Chevron Corp. (NYSE:CVX) reported a 30% drop in earnings and announced it was cutting spending and eliminating its stock buyback program (which has been running at $5 billion a year).
Wall Street strategists are now lowering their earnings estimates for the S&P 500 to take into account the effects of lower oil prices and the higher dollar. This should place additional downward pressure on stocks.
According to Bloomberg, investors have lost $393 billion in energy stocks and bonds so far, something that wasn't factored into the optimistic reports about the positive effects of lower oil prices on consumers.
Here's a little bulletin: when the world's most important commodity experiences collapses in price by more than 50% in a period of just six months, it isn't good for anybody – not for consumers (who aren't just consumers – they are also investors, businessmen, and active members of a broader economy), investors or markets. And the reason is that lower oil is a symptom of something much more serious – the weak global economy that I described above.
Prepare for Tough Times Ahead
Through that lens, lower oil should be seen as a major warning sign that both the market and the economy are in for tough times.
And that is what January's stock market action is telling us. Bond and commodities markets have been signaling for months that the global economy is in trouble. Last month, stocks finally caught up. Janet Yellen is going to have to pull another rabbit out of her hat to keep stock prices levitating in the year ahead, and she is quickly running out of rabbits.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.
"Russia has increased its aggression in the Ukraine."
Can we please dispense with the neocon propaganda?
If you want to make this claim, then support it. Have Russian divisions crossed the border? Where? When? Which ones? Which Ukrainian regular army units and militia cotingents are they engaging? Where?
Don't be a parrot. Don't drink the kool-aid. Investigate for yourself.
any fool with Dish TV can get the other more honest side of the situation in Ukraine by watching RT and not the same old corporate crap spread by our mass so called media.
I was in Donetsk from August 2013 to January 2014 and In the Ukriane for a good chunk of 2014. It's real and both sides have a dam the torpeddo's full speed ahead attitude. There are other spots in the world that are heading for serious trouble as well. China and the South China sea, India and Pakistian over fresh water, The middle east as always but worse with ISIL,Syria, Iran,Oil taking a dive and new settlements going up in the west bank. Add that to a unnatural 6 year market with out a big realignment. It's coming and will… Read more »
So fallingman is saying that Ukrainians are invading Ukraine?
And those Ukrainian invaders are encamped in Russian tents on Russian land, using Russian vehicles, guns, bombs, tanks, medical supplies, and equipment while wearing Russian boots and uniforms (minus the ID patches) and speaking Russian?
Yes, that makes a lot of sense.
That's quite a story. Care to supply any EVIDENCE? Or do we just get more claims based on absolutely nothing?
Why looky here at this breaking new item. How interesting: Ukrainian Government: "No Russian Troops Are Fighting Against Us" The Chief of Staff of Ukraine's Armed Forces, General Viktor Muzhenko, is saying, in that news-report, which is dated on Thursday January 29th, that the only Russian citizens who are fighting in the contested region, are residents in that region, or of Ukraine, and also some Russian citizens (and this does not deny that perhaps some of other countries' citizens are fighting there, inasmuch as American mercenaries have already been noted to have been participating on the Ukrainian Government's side), who… Read more »
I have for many months and have discovered that the Russian Trolls such as yourself who are used to misinform and confuse the American internet , will continue to do so. However as Americans become more informed, trolls like you will only continue to drain Putins coffers until another downgrade in your economy shuts down the Ruble permanently and you will only have the RT (Russian Times) to place your comments on. Or maybe you will learn how to fire Grad missiles on the eastern edge of Mariupol as a member of the Russian army that doesn't exist.
I love it. Russian Troll. "My" economy. Ha. Is that all you've got? Mindless jabber. Can't answer the questions I posed above. Got it. I have ZERO association with Russia or Russians. I'm a completely independent observer. American born … NY … Carolina raised. Financial professional for years. I just don't like to be lied to, especially from official sources. You want to drink the kool-aid? Go ahead. I'm not used by anybody pal. Putin IS a thug. There's a shocker. And in this case, he's actually less thug than any of "my" government's "leaders." In the thuggery competition, we're… Read more »
General Viktor Muzhenko, The Chief of Staff of Ukraine's Armed Forces, says you don't know what you're talking about … as if that were ever in doubt.
See above.
But what does he know, right? He's probably a Russian troll.
Agreed. Good article, but leave out the geopolitical propaganda.
I like this article, in fact I enjoy Moneymorning for about a year now. The site says I have points. How I got them and what they're for, I haven't the slightest idea. Everywhere it's the same, correction coming, crash imminent, lower expectations. The Central Banks are buying Gold. They created this mess, if that's their plan for surviving it ought to be a citizens also. That's just how I see it.
Hi there – you can use those points for big discounts on most of our trading services and publications; the more points you have, the bigger the discount. You can call on 1-888-384-8339 to see what you can get for your points balance, or drop us a line at customerservice _at_ moneymorning.com. Hope to hear from you, and thanks for being a fan!
-Ed.
Hasn't the world been fighting these same headwinds since at least 2008? Doesn't the stock market "climb the wall of worry"? As long as QE, U.S. growth and debt financing continue to maintain markets aren't we all going to continue this present course of low growth, relatively low inflation, low interest rates and sustained high stock markets? I tend to believe you more than others, but I have been hearing the same mantra for low these many years and nothing bad happens.
An understandable sentiment. And it looked as if the Soviet Union would never fall too. For what it's worth, I think we have a perceptual problem. We see things in terms of a human lifespan, where the time between the tech wreck and the 2007-2008 meltdown seemed like a long time. And it seems like a long time since that meltdown. In historical terms, those roughly 6 year interludes are tiny blips. I suspect people will look back from years in the future, following an epic collapse, and marvel at how "we" couldn't see the thing unraveling. Inevitable? Yes. Imminent?… Read more »
The Un-tied States are on life support….. the "markets" and "investors" are wringing the last bit of blood out of the veins of what was a huge productive cow (aka nation state). Hatching up unsupported theories to try to "blame the US condition on Russia or China" is superfluous to say the least. Russia and certainly China are the future… on the path upward, anyone who reads alternative news sources instead of swilling up the propaganda on US main stream news knows this… Why not call it the natural historic swing of the pendulum and analyze the situation from that… Read more »
Correction
Excellent writings as per usual -the truth will eventually 'out' and I hope it is the casino high rollers and bankers that are manipulating the markets in Wall Street that will fall the hardest
Regards
Mike Harvey
Resident in Ireland
We are long past the time that normalization of interest rates should have begun. Such normalization would not only suggest a sustainable economic situation, but would actually spur demand as investors, retail buyers, and all other buyers of actual products would become motivated to act rather than delay assuming that any necessary indebtedness will be no more costly tomorrow than it is today. Further, a very large, and generally affluent, segment of consumers have been shut out of purchasing by near zero return on their savings. Unless they have "recklessly" speculated on stocks, return on capital, upon which many retirees… Read more »
enjoyed your article very much; I hope you predictions are mitigated by some "Good Luck".
Best regards,
Franl L Bresee
I enjoyed reading this article and yes, a market correction/crash has been predicted for a long time now. I believe the reason the market has been rising for so long is the Fed's policy of holding interest rates artificially low. Interest rates should have been allowed to rise to a normal level years ago to allow the economy to stabilize. If savers were receiving a normal interest rate they would have more money to spend in a consumer driven economy. Instead, companies have been using cheap money to buy back shares which drives stock prices up but doesn't support a… Read more »
Here's the bigger dramascape that Lewitt's forecast draws…the problem is not the absolute level of debt or a certain ratio (though he cites the best indicators), it is that the policy makers DON'T CARE. This is not an "opinion"–it is an observation based on their public statements and policy decisions. The ratio does not matter to them (again a "fact"–evidence in the form of their OMISSION of any such argument in their own defense). They believe in TWO things…the New World Order (end of US hegemony, leadership, self-governance, and dollar) and that no debt marker will ever be called. This… Read more »
Anything on here about corporate stock buybacks being used to inflate stock prices and ceo salaries? Interesting that last week both gold and the USD went up. S&P is just bouncing around sideways on mostly low volume. AAPL gaps up 4$/share and suddenly the mkt. is "up", except it isn't. Correction coming then more QE.