In terms of the individual components of the indicator, economic growth remains at +1 given our positive views on global growth.  The global PMI moved up 1.1 to 53.2 in November with strong gains in the developed markets, particularly the U.S.  Global export orders also hit a 32-month high, supporting the view that global trade is picking up, which should support better growth in the emerging economies.

Corporate profits remain at +1 but, with profit margins at all-time highs, we expect that may get reduced to 0 in the not too distant future.  While companies have done an exceptional job of growing their profits at a greater rate than sales, this will be difficult to continue to do.  We expect single-digit profit growth in 2014.

In terms of stock valuations overall, we remain at 0 with this indicator, as we are close to the middle of the long-term range.  Although we could argue for higher stock market earnings multiples given that interest rates are so low, we don’t want to count on this.  We continue to see stocks as having decent long-term value and are nowhere near the ‘bubble territory’ we saw back in the technology market of the late 1990’s.  A similar sentiment was echoed by incoming U.S. Federal Reserve President Janet Yellen in her recent Senate Testimony.  Ms. Yellen’s testimony soothed the bulls by downplaying any concern that the market is wildly outrunning fundamentals. She said that “stock prices have risen pretty robustly but if you look at traditional measures, you would not see stock prices in territory that suggests bubble-like conditions”.

The chart below bears this out as it shows the forward PE Ratio for the S&P500 over the past 30 years.  The current value falls right in the middle of the long-term range.  While we have been able to look for higher valuations and stronger earnings growth over the past few years, the argument for much higher valuations probably doesn’t apply anymore. Earnings growth will become much more important to future stock gains.  We continue to believe that the strongest earnings growth will come from the technology sector, financials and global cyclical industries such as energy

PE Ratios Below Long Term Average

Monetary Conditions have been reduced to +1 for the first time in five years as the imminent removal of the extremely friendly monetary conditions in the U.S. has to be taken into consideration, even if we don’t see interest rates rising anytime soon.

The biggest drop in our Asset Mix Indicator, however, came in the Sentiment Indicators, which are the most ‘short-term’ oriented of our five indicators.  Bullish advisory sentiment has increased in most of the key surveys we follow and bearish sentiment has retracted significantly.  Meanwhile, insider selling has increased back close to record levels, suggesting that senior management are viewing recent gains as somewhat extended.  What worries many of those with more bearish views is that, this year, stocks have risen faster than earnings as investors expressed optimism that faster profit growth is around the corner.  As a result, the forward price/earnings ratio on the S&P500 rose to 15.5 from 12.9.  That is the largest expansion in the P/E ratio for stocks since 2009, when the market was recovering from the depths of the financial crisis.  While the 15.5 PE level is nowhere near the peaks seen in 2000 and even in 2007, stocks could use some further support from earnings growth in order to move ahead in 2014.

Gold has been one of the few disappointing sectors this year as gold bullion prices continued to move lower from the late 2011 peak.  Gold stocks have performed even worse than bullion as rising production costs combined with falling prices to erode profits.  Valuations for gold stocks had also been falling prior to the peak in gold prices as the flow of funds in that sector went straight to the gold ETF rather than the riskier mining companies.  The net result that gold stocks have performed miserably, falling 50% so far in 2013 and by over 65% from the August 2011 high.

1 2 3