By Secular Investor
Big banks usually promise their clients all sorts of things and always continue to issue recommendations to continue to invest in stocks and bonds (obviously to rake in their fees), UBS chartists and technicians Muller and Riesner have now publicly stated we might have seen another top of the S&P 500 index.
And when Muller and Riesner speak up, the investment community listens, as these two technical analysts have correctly predicted the two previous corrections (and the recent increase in the gold price), so they do enjoy some respect in the market. They were already correct in seeing the S&P hitting their target at 2050 points earlier this week, but this target was reached much faster than originally anticipated, and we think it’s now fair to say we have seen two V-shaped corrections on the stock market and these corrections might have been wiped out too fast, too soon. Indeed, apparently to the UBS-analysts, the S&P index has now reached its most overbought situation since 2009, and that’s quite a statement to make!
Of course, at Secular Investor we don’t just act on what just one source claims, but another interesting fact has hit the wires on Friday (and it’s probably not a coincidence this news was released on a day the stock markets were closed). The American economy did grow in the final quarter of last year, but according to the Bureau of Economic Analysis, this did not coincide with an increase in the corporate profits. And that’s not something we should easily ignore, as the BEA said the adjusted pre-tax profit of the companies fell by 7.8% in the fourth quarter.
That could and should be seen as a huge disappointment, and this might indeed rattle the markets and ruin the over-excitement. This also emphasizes the point we have made almost eighteen months ago, in October 2014 (!).
‘Our message is that this can’t continue forever. The stock markets will have to face a reality check somed day as we are on a completely different point in the cycle compared to March 2009.[…] The proportion of the cash flow which is being used to buy back shares has almost doubled in the past decade whilst the capital expenditures have decreased. That’s a very dangerous situation as companies don’t only have to spoil their shareholders, they also need to think about the future and investing in new assets is an absolute necessity. ‘
And indeed. The next chart shows you the share buyback level has reached an almighty high level.
But it gets worse. In excess of 30% of the companies is spending MORE on buybacks than they generated in free cash flow. This means that if you would try to pull up the numbers of companies whose share repurchases + dividend payments are higher than the amount of free cash flow.
When the music stops, the impact might be enormous. A substantial part of these buybacks are funded by increasing the total amount of debt on the balance sheet, fueled by the low interest rate environment. Once the interest rates start to increase again, the cost of debt will become more expensive, and companies will have to focus on reducing the net debt again, rather than reducing the share count.
All signs are pointing towards an overbought general market, so be prepared for a correction.