There are many reasons why investors ought to be thinking about managing capital risk today. In the 90 days since the election of President Trump, the market has been on an unsustainable run.
Yesterday I remarked that Apple (AAPL) had increased it’s market cap in that brief span by about $130 billion. This morning I see that over the past 90 days the market performance has been +31.4% for Trump’s new best friends Goldman Sachs (GS) and +23.7% for JP Morgan (JPM). Yes, that’s over three months, not three years. In addition, American Express (AXP), Boeing (BA), Disney (DIS) and IBM (IBM) are up +19.6%, +16.6%, +16.4% and +15.1% respectively.
By my count, fully 40% of the Dow 30 constituents have been running up in price at an annualized rate of greater than +50%, and that is clearly “an ugly, big fat bubble” or whatever Trump called the market even months before he was elected.
Most investment professionals agree that the market is late in the bull cycle, one of the longest in history. In terms of risk management, the market’s point of cycle is a determining factor, which I want you to consider.
Early in a new long-term bull cycle, like we had in 2Q2009, risk management ought to have been directed to a study of corporate fundamentals because we know many of the fundamentally weakest of companies turn out to be cycle failures; however, late in the cycle, market sentiment takes control of prices, which move higher because they are. We call this phenomenon multiple expansion. In simple words, people are acting like people in crowds, chasing prices higher together. Such is the case today. It doesn’t seem to matter that two-thirds of the Dow 30 stocks are trading with Price-Earnings multiples at or higher than 20, and about one-quarter of them are at or above a 30 multiple.
Reminds me of the idiot analyst that told the CNBC audience in the year 2000 that GE’s PE multiple of some 50+ was fine with him because the price was on the rise. Well, it was until it hit the wall, bouncing back so hard, investors were left reeling. Today, GE’s PE multiple is close to 30, which is nose-bleed high unless of course you buy the current DC lemonade that GE’s military complex is going to benefit greatly from the next war that Trump says he doesn’t want but seems to be heading for.
So, you get my point that PE multiples are unsustainably high, but could go higher in the interim before they hit the wall after investors see that, for most companies, absolute revenues and earnings are not growing at nearly so high a pace, if at all.
So, now we should be watching the whole market, not just a few companies unless of course those are ones that need our attention for the reason I’m about to give.
Many investors and portfolio managers are now focused on the current high flyers in the Dow 30, like Apple, Goldman Sachs and JP Morgan, whereas I think they should be looking elsewhere – to the Oilers Exxon (XOM) and Chevron (CVX), in fact.
Here’s my thinking: all prices fluctuate, but as a group they tend to advance in a rolling action with – in a bull market — the strongest ones get weaker being replaced by the weakest ones getting stronger. But, at the onset of a bear market, the weakest get weaker, so the whole group starts trending down. This means that we should anticipate some weakness in the AAPL, GS and JPM group; however, if the XOM and CVX constituents of the Dow 30 also get weaker, that represents a sea change in market sentiment. Those unsustainable PE multiples will soon be hitting the wall.
To trigger higher prices in XOM and CVX, there is one price that must rise, and that’s the price of West Texas Intermediate and Brent crude oil. Despite a move in the price of oil from the low 40s to the low 50s, all the Oil & Gas ETFs are stuck at disappointing price levels. That must change for the broad market to lift from here.
If you want to stay on top of this idea, then go to StockCharts.com and run a comparative chart of XOM:GS or CVX:AAPL, for example. Unless you start seeing a reversal of the downtrends, I think the broad market is going to experience headwinds that could develop into gales that require you to seek safe harbor.
My thoughts anyway. I’m sure you have your own. I’d like to hear them.
All the best,
/Bill
