U.S. Stocks Mania: Earnings, Valuation & Sentiment Review

Let's take a quick walk through the fundamentals, valuation and sentiment surrounding U.S. stocks. First up we have fundamentals which can be analyzed through earnings and sales. However, as Lance Roberts described this past week the two can be very different at major market turning points due to accounting gimmickry by corporations.

Operating and reported earnings have turned sharply lower over recent quarters which has historically been associated with major market peaks. As shown below, it is also important to notice that revenue has tended to lag these downturns in earnings previously. This is because the measures used to substantially boost profitability from each dollar of revenue generated through accounting gimmickry, share repurchases, and cost cutting are finite in nature. When the effect of those manipulations fade, so does the inflated profitability generated from each dollar of revenue.

Up next we have the number one reason to buy U.S. stocks touted by money mangers everywhere: dividend income. We are told dividend income crushes the returns you can receive investing in most bonds today so stocks are "the only place you can safely park your money." What is not mentioned during these presentations is when the economy slows dividend payments can be cut or removed entirely. The chart below shows the number of dividend cuts in Q1 and Q2 this year are sharply above normal recessionary levels. Investors counting on this income for retirement will be quite upset when they receive a letter in the mail letting them know it's no longer coming.

The next chart helps put a valuation perspective on where U.S. equities stand today relative to their current earnings. Using five popular gauges of value the colored circles show where the S&P 500 would be if investors valued earnings today as they have historically. Stocks are 20% to 50% overpriced depending on which metric you choose to use:

What is helping stocks surge to these incredible valuations? Margin debt. March 2015 data shows investors have crossed into new record highs for the amount of money they have borrowed to purchase stocks. The more money investors borrow to purchase stocks the greater the waterfall decline will be due to margin calls and debt liquidations on the way down.

GMO released their 7 year expected return chart this week for various asset classes based on current valuations looking forward. This chart became famous after it was one of the few warning signals at the 2000 peak (it called the 2007 returns from 2000 perfectly). Investors today can expect to lose money in both U.S. stocks (-2% to -3.2%) and U.S. bonds (-1.2%) over the next 7 years. This could occur through a major crash and then a large subsequent rally which would bring investors back (close) to whole from today's prices.

While GMO is nervous about the future the majority of money managers (those that make their living based on keeping your assets in the stock market casino) are not. Barron's Big Money Spring Poll showed 93% of money managers were either bullish or neutral, meaning the worst case scenario would be a market that moves sideways (most think it's going higher). Only 5% polled were bearish.

My favorite new mania headline of the week came from MarketWatch, Hopefully there is no comment necessary on this one:

"Celebrating the new Nasdaq high with a call for 10,000 by 2016" 

The best new mania picture of the week; The Warren Buffett shoes. You know things are getting frothy when you see money managers walking around with these at the country club.

We are truly at historic times in terms of paper asset euphoria The coming crash when the madness finally subsides should be equally epic.