/ September 29 / Weekly Preview
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Monday:
N/A
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Tuesday:
JOLTs Job Openings
CB Consumer Confidence---
Wednesday:
ISM Manufacturing PMI
ADP Employment Change
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Thursday:
Initial Jobless Claims (220K exp.)
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Friday:
Non Farm Payrolls (39K exp.)Unemployment Rate (4.3% exp.)
ISM Services PMI (52 exp.)
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Monday:
Carnival Corporation
Progress Software Corporation
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Tuesday:Nike, Inc.
Paychex, Inc.
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Wednesday:
ConAgra Brands, Inc.
Cal-Maine Foods, Inc.
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Thursday:
N/A
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Friday:
N/A
To Take or To Not Take Profits
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U.S. stocks appear “fairly highly valued,” -- Jerome Powell’s statement from last week echoed the sentiment that many analysts warned about: forward returns may be disappointing, given the price that investors are willing to pay for every dollar of earnings.
Alan Greenspan’s 1996 “irrational exuberance” speech also comes to mind, but that was served with more pathos and drama at the time. Both central bankers referenced a tension in regards to monetary policy: while the Fed has no explicit mandate to target asset prices, these become a problem when they feed back into potential financial instability. That’s the only reason valuations matter for the Fed.
Before going any further, we have our own take on valuations that we’d like to emphasize. Based on actual EARNINGS, valuations appear extreme — by some measures close to dot-com euphoria levels. Take the Shiller CAPE ratio for example, which compares the S&P 500's current price to its average inflation-adjusted earnings over the last 10 years. This is now hovering around 39, while the maximum recorded was closer to 45.
By this measure, the S&P 500 has already surpassed the peak valuation levels of 2021-2022. But what if we study a measure not tied to earnings? Such as Enterprise Value to Sales?
Enterprise Value to Sales (EV/Sales) is a valuation metric that measures a company's total value (which includes market capitalization, debt, and cash) relative to its annual revenue (not earnings). Why would investors prefer looking at EV / Sales rather than any Price / Earnings multiple? There are several reasons:
P/E is meaningless for companies with negative earnings, while EV/Sales can still provide insight into value based on revenue generation;
Earnings can be distorted by accounting practices, tax strategies, or one-time charges, whereas sales are more straightforward and harder to manipulate;
Investors in high-growth sectors (which include popular names in the S&P 500) often prioritize revenue growth over current profitability, making EV/Sales more relevant.
By this metric, when aggregated over the top companies in the S&P 500 index, the average sits at 8.05x, close to the mid-point recorded since 2016. The top in 2021-2022 was over 12x by comparison. Not cheap, by any means, but far less alarming than media headlines would suggest.
To be sure, a far more alarming subject is the ballooning rise in unprofitable companies listed on US stock exchanges, which reported negative EBITDA for the past 12 months. Now sitting at over 2000 stocks, this figure more than doubled since 2016, when just 800 companies were in the red.
Naturally, very low (or non-existent) earnings can spike valuation metrics which rely on EBITDA and spook investors who don’t dig a little deeper.
Do we believe speculation exists in the stock market? Certainly, especially related to AI stocks and certain IPOs which debuted recently or are in the pipeline. This is more of a concern than actual multiples.
Powell’s comments landed after five straight months of equity gains and one of the longest stretches in history without a single 2% daily move in the S&P 500. In this context, some investors took it as a “cold shower” of sorts and chose to take risk off the table.
Since we also work with clients on a regular basis, we can sometimes garner insights into their thinking. And last week, we got several calls related to “taking profits” in portfolios. This is an understandable and potentially smart move, but one that does not indicate excess exuberance -- rather a fear of losing unrealized gains as the markets retreated from all-time-highs.
We don’t think Powell intended to cause panic, by any means. The Fed simply knows that inflated valuations make markets more fragile if growth disappoints or credit conditions tighten.
Quarter-end rebalancing also played a role in last week’s bout of selling. Large institutional investors, pensions, endowments, and insurance companies must rebalance portfolios at the end of September. Given the last 3 months of performance, flows will likely mean trimming equity weightings and redeploying into lagging sectors like bonds or international markets.
Does this mean that the bull market is over? Certainly not. It’s simply a supply / demand factor that is likely to weigh on asset prices during this period. Specifically capital is likely to rotate out from high-performing sectors such as tech (XLK), into relative laggards such as Staples (XLP), Real Estate (XLRE) and Healthcare (XLV).
Given a seasonally weak period (which end in mid-October), we wouldn’t be surprised to see more volatility in the days ahead. However, we would like to point out that a very effective BUY signal has just triggered.
Our newly developed signal triggers on the last day when both the MACD and Medium-Term GEX for SPY are both negative. The last day was Thursday, with Friday confirming the end of the period. For investors waiting to “buy-the-dip”, this signal basically says “this was the dip”.
Technically, the market remains highly extended above its 200-DMA, but this is not necessarily a bad thing. Fundstrat's Tom Lee argues that it’s not when SPY’s extension is at 10% (like right now) that’s the problem - local tops are seen when the extension is somewhere between +13% and +15%; “that would imply 6,950."
Our own backtesting confirms this, with SPY’s 200-day Sigma Score now at 0.72. Usually, when extensions above 0.7 occur, they tend to last at least several months (shown below the main chart). The last cluster of 0.7+ readings in Sigma Score has just started in mid-September and suggests upside into year-end, volatility notwithstanding.
Resistance lies at $692 (R1) and support is now at $653 (M-Trend level, 20-DMA).
Our Trading Strategy
Currently, our signals are telling us to stay the course, remain invested, and ride out any seasonal volatility that may come as a result of rotation or supply / demand dynamics.
Even if our portfolio takes a hit due to profit taking in the short term, the medium term outlook is fine for now.
If technical conditions unexpectedly worsen, that would be a better sell-signal than trying to time a “top”. Below the last close price, support gets harder to come by. For example, a 200-DMA retracement would imply a -10% decline. SPY’s Low Trendline sits at $579, -12% below the last close. It’s important to understand that even in the eventuality of such a decline — we would still be in a bull market. However, we wouldn’t want to let our portfolio get there, but rather harvest profits on the way down, as our clients suggested.
With all technical signals positive, however, there is no need to take such action… yet.
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Disclosures / Disclaimers: This is not a solicitation to buy, sell, or otherwise transact any stock or its derivatives. Nor should it be construed as an endorsement of any particular investment or opinion of the stock’s current or future price. To be clear, I do not encourage or recommend for anyone to follow my lead on this or any other stocks, since I may enter, exit, or reverse a position at any time without notice, regardless of the facts or perceived implications of this blog post. I currently do not own or plan to own any position, long or short, in the securities mentioned.
I am not a financial advisor licensed in the United States. Nor am I providing any recommendations, price targets, or opinions about valuation regarding the companies discussed herein. Any disclosures regarding my holdings are true as of the time this article is written, but subject to change without notice. I frequently trade my positions, often on an intraday basis. Thus, it is possible that I might be buying and/or selling the securities mentioned herein and/or its derivative at any time, regardless of (and possibly contrary to) the content of this blog post.
I undertake no responsibility to update my disclosures and they may therefore be inaccurate thereafter. Likewise, any opinions are as of the date of publication, and are subject to change without notice and may not be updated. I believe that the sources of information I use are accurate but there can be no assurance that they are. All investments carry the risk of loss and the securities mentioned herein may entail a high level of risk. Investors considering an investment should perform their own research and consult with a qualified investment professional.
I wrote this blog post myself, and it expresses my own opinions. I do not have a business relationship with any company whose stock is mentioned in this blog post. The information in this blog post is for informational purposes only and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.
The primary purpose of this blog post is to share industry expertise and research and receive feedback (confirmation / refutation) regarding my investment theses.