Bank of America (NYSE:BAC) Epitomizes Market Sentiment
When looking at the PE multiple of the S&P 500, very few people would call this an inexpensive looking market. Instead, with a PE multiple over 23 times earnings, negative earnings growth, and contractions in revenue, smart people are questioning the valuation of the market at this time. Looking ahead, 18 months down the road the PE multiple assuming that analysts are correct about all of their earnings estimates between now and then we’ll only be reduced to 17.36 times earnings, which is still a historically high valuation level. That’s a long time to wait for a still high multiple.
The PE multiples I am referencing are based on as reported earnings taken directly from Standard & Poor’s website.
I would take that argument even further and suggest that this market is extremely frothy and poised to decline, but that certainly seems like the wrong side of the fence given the aggressive increases that have happened lately, so it’s important that we review how we got here. Maybe, in doing so, we can draw additional conclusions.
This all started the week before Brexit. Institutional investors placed heavy bets that the vote would be to remain in the EU, they drove the stock market higher ahead of the vote, but they were caught completely off guard when the vote turned out to be negative. Initially, those big bets had massive associated losses, but two things lingered immediately thereafter as well.
First, there were only a few days left to the end of the quarter, and the 4th of July holiday was coming up too. Traditionally, investors do not like to hold short positions over extended weekends, but in addition, at the end of quarters, institutional investors also want to push stocks higher to dress up their portfolios so that they can maximize their bonus. This is called window dressing, and it’s also probably why they made the initial bets.
Those two additional phenomenon helped influence the market to turn on a dime on the heels of Brexit. Initially, it fell on its face, the bets that were made were severely under water, but those investors who bet on Brexit in an effort that appears to be aimed at realizing additional bonuses before the end of the quarter, also seemed to step up and buy on dips. That left them with much more than they otherwise would want to hold, or so I thought, but there has been very little selling subsequently.
Many institutional investors seemed content to sit back and let the smaller investor and foreign investor bid the market up after the 4th of July holiday, and with speculation about QE ringing through the walls of wall street there was upside momentum in the market.
Since then, there have been a series of potentially negative events that have had little or no influence on the market other than to be used as a tool to spur additional buying. The BoE did not cut interest rates or add stimulus as they were expected to do, but instead of being treated as a disappointment the street use that as an additional catalyst to buy with the expectation that they would be adding stimulus in the future (But were they listening?). Even though the BoE said it was being patient as it evaluated the situation without acknowledging that they would or would not add stimulus in the future, but simply that they would not add stimulus or cut rates at that given time, they still bought. The hope of additional QE spurred buying.
More recently, two additional potentially negative catalysts have hit. The “terror” attack in France and the failed coup in Turkey both were potentially negative news events that did nothing more but instill confidence in those bidding up the market. Overconfidence…
Now, with negative earnings expectations already built into the market investors are holding market levels firm with a hope it seems that earnings are not as bad as expectations. In fact, we are already seeing them bid up prices when earnings growth and revenue growth are both declining, even though prices are already high and simply because earnings were not as bad as they were expected to be. A case in point is Bank of America (NYSE:BAC), whose stock was up about 4% after reporting earnings that were not as bad as expectations, but earnings that were still awful, and the stock rose even though the stock had already risen by about 15% beforehand.
Whether or not Bank of America should have risen given those circumstances is a rather moot point, because we’re simply using it to describe the environment we’re in today. What is bad is spun positively, investors are simply ignoring bad news and risks, and they are bidding the market higher without concern. My final point may explain why that is happening.
Our concern is, however, that volume levels are drying up.
Where two weeks ago volume levels were strong as this rally was initiated, volume levels have tapered off again, and that’s a sign that those big money players are curtailing their momentum. There is a strong possibility that they are finally at a point where they may be tempted to sell into the rally, but that clearly hasn’t started in earnest, at least not aggressively enough to cause markets to decline.
There’s very little evidence that would suggest that those investors who took big bets ahead of Brexit in an attempt to pad their ability to realize bonuses ahead of the end of the quarter exited those positions or the positions they added to that bet in the aftermath of Brexit. Although it is possible and we can never be absolutely sure, the volume levels on the sell side do not suggest that aggressive selling pressure ever surfaced that would have matched the aggressive buying in the few days before Brexit and the few days afterwards. I still consider those to be bets of a short-term nature and likely to be the first to be taken off the table when the market does stall and begin to turn lower.
The question is, will it ever happen?
Will the market ever care that the PE multiple is over 23 times earnings, that growth rates are negative, that revenue is actually contracting, or that margin debt levels are at an all-time high?
My answer is, eventually they’re going to care. When they do this thing’s going to fall on its face.
I suggest we look at our LETS Strategy as an option too.