I had an interesting conversation the other day with a friend of mine who asked a very compelling question: with margin debt in the equities market hitting a new all-time high—$401 billion on the NYSE in September—is this a sign of a market top?
To find out what this really means, we have to dig a little deeper into how this can affect the equities market.
An increase in margin debt is really a story of investor sentiment. As the equities market moves up, this gives people more confidence and therefore increases investor sentiment. Many investors then borrow money to invest in the seemingly bullish market—this creates margin debt.
Now, this all sounds great on the way up, but in the end, the problem with higher levels of margin debt is twofold.
First, the very fact margin debt is increasing can be looked at from various angles. One is the obvious point of view that investor sentiment is becoming increasingly bullish on the equities market, so people are borrowing to get in on the action.
Another way to look at higher levels of margin debt is that while borrowing money to put into the equities market is bullish, as more money is chasing the same number of shares, at some point, if everyone is in the market, who’s left to buy?
Second, the real problem with high levels of margin debt is not on the way up, but when the equities market begins to turn. While investor sentiment can shift rapidly, the problem with investing on borrowed money is that it becomes far more painful on the way down.
This … Read More
When it comes to the recent batch of corporate earnings releases, some investors might be cheering. But if you look a bit closer at the results, you will notice the underlying fundamentals aren’t as strong as they first appear.
One thing to remember: in the equities market, it’s all about expectations. A company might report corporate earnings of $100 million, but if analysts in the equities market were expecting $150 million, the results would actually be disappointing.
The reason for this is that the equities market is a discounting mechanism for future corporate earnings. Analysts and investors estimate what the next 12–24 months might bring in terms of corporate earnings and accordingly adjust their valuations for various stocks in the equities market.
What’s interesting to note in this corporate earnings season so far is that the spread between actual and estimated corporate earnings is declining. This means companies are having difficulty exceeding expectations.
So far, 244 of the S&P 500 companies have reported corporate earnings, and while 75% have beaten corporate earnings estimates, on average, they have only exceeded these expectations by 0.8%. The four-year average is 6.5%. (Source: FactSet, October 25, 2013.)
And if you listen to executives at various companies within the equities market, you will notice another common theme: companies are having difficulty finding and generating revenue growth.
Of the S&P 500 firms in the equities market that have reported corporate earnings so far, only 52% have exceeded revenue estimates—far below the four-year average of 59%.
This is why they are issuing dividends and buying back shares; they can’t figure out a better way to invest the … Read More
With corporate earnings season fully underway, the equities market is continuing to move skyward, and you’re probably thinking to yourself that it’s smooth sailing from here.
But hang on. Let’s not jump to conclusions so fast; there is more than meets the eye.
The equities market needs a growing level of corporate earnings to maintain its current valuation level. Essentially, you wouldn’t pay more for a company if its earnings were about to decline. I think we might be reaching a level in the equities market where earnings are being overvalued.
There are signs that the equities market might be pricing in a far too optimistic picture for the near future. As an example, of the 263 companies that have reported their corporate earnings so far, 43 firms have issued negative guidance for their corporate earnings, with 11 companies increasing their earnings guidance. (Source: “Earnings Insight,” FactSet web site, July 26, 2013, accessed August 1, 2013.)
What this tells me is that companies are cautious regarding the second half of 2013 and their ability to continue growing corporate earnings at an accelerated rate. If the equities market is pricing in a continuation of strong earnings, investors might be disappointed later this year.
While the current quarter of earnings appears to be strong on the surface, digging deeper shows an interesting anomaly. So far, 73% of companies’ earnings have beaten estimates, which the equities market obviously likes, and this has helped boost the market higher.
We all know how the corporate earnings game works: estimates are lowered so that companies can report that they exceeded what was expected. But companies exceeding … Read More
Chinese initial public offerings (IPOs) could be hot again this year, but don’t look to America as the breeding grounds: the flow to the U.S. is dead.
The big market for Chinese IPOs will be at home in China where there could be as many as 349 IPOs this year, according to a calculation by Goldman Sachs. (Source: “IPO deep dive: The Sword of Damocles or Paper Tiger?,” Goldman Sachs web site, January 23, 2013, last accessed May 14, 2013.) Of course, we have seen only a trickle this year, so the Goldman estimate seems to be more fiction than fact.
In the U.S., there are no Chinese IPOs scheduled for the immediate future, a stark contrast to the 60 Chinese stocks that debuted on U.S. equities markets from 2008 to 2011.
The more recent numbers look even worse, and tell us a tale of misfortune for Chinese IPOs.
In 2012, there was one Chinese listing on U.S. equities markets, but we saw the delisting of several Chinese stocks that have been taken private. Since August 2011, 23 Chinese stocks have delisted from U.S. equities markets, according to Money Week magazine.
Based on what I have been reading, I doubt that there will be much activity this year or next for Chinese IPOs, unless the rules of engagement for financial reporting and auditing are made better and meet U.S. standards. The Securities and Exchange Commission (SEC) wants any Chinese company aiming for access to U.S. capital markets to use one of four approved U.S. Big Four auditors. That request is fine, but the problem lies in the SEC also wanting … Read More
With capital shifting into the perceived safety of blue chips and large-cap stocks, small-caps and technology stocks have been declining on the charts.
Given the advance so far this year in the equities market, it’s understandable to expect some hesitancy.
The Dow is up 13.4% as of April 12, and it’s on pace for a gain of 47% on an annualized basis.
I doubt this will happen and expect market adjustments in the equities market along the way. The same goes for the S&P 500 and the other key market indices.
Small-caps in the equities market have also fallen off since the end of the first quarter.
At the back of the pack is the technology sector; but there has been a lack of strong leadership from any sector, including the semiconductor, Internet, and technology sectors, in general.
The following chart shows the recent movement of the three sectors (semiconductor, Internet, and technology) since March and their sideways direction.
Chart courtesy of www.StockCharts.com
Without any leadership in the equities market, the NASDAQ and technology stocks will continue to drift. However, there are some opportunities for speculators searching for contrarian situations.
The Internet sector is flat and lacking a clear direction.
In the stock chart below, the First Trust Dow Jones Internet Index (NYSEArca/FDN) fund shows the sideways channel that has been in place since late January.
Extrapolating on this data, I don’t see any strong and clear signs of a breakout at the top channel line, but if you think longer-term, there are opportunities in the equities market.
Chart courtesy of www.StockCharts.com
The “Best of Breed” in the Internet sector … Read More