Trampoline anyone? That's our internal image of the past few months, with the S&P 500 falling 7.4% from Sept. 18 to the Oct. 15 bottom, and then rising more than 10% as of yesterday's close. Both the Nasdaq and the Russell 2000 are up over 11.5% from their mid-October lows. The S&P 500 has now been closing above its five-day moving average for 20 consecutive days, something that has happened just three times in the last 20 years. When this has happened before the market rally reversed within four weeks.
Looking at valuations, the Shiller price-to-earnings ratio of 26.8 has the S&P 500 well above the historical norms, with a mean of 16.56 and a median of 15.93.
U.S. total market capitalization as a percentage of GDP is also in a range not seen since the heady days of the Great Dotcom Bubble/Bust. If we look at GDP growth rates across the world in the fourth quarter of 1999 and compare them to today, this number is even more concerning. Back when the market cap-to-GDP ratio was in this area, economies around the world, with the exception of beleaguered Japan, were growing at a decent pace.
Today the U.S. economy, while stronger than most of the developed world, is growing at a much slower pace. Japan is the proverbial bug in search of a windshield and those oncoming headlights are getting awfully bright. The eurozone is struggling to have any economic growth at all. Germany's economy has been benefiting significantly from exports, enjoying an artificially suppressed exchange rate courtesy of the impact of other nations within the eurozone, but exports in the nation fell 58% from July to August and industrial production shrank 4%.
China, the nation that helped bull the global economy out of the last financial crisis, is slowing markedly. It is also facing a debt problem. From 2002 to 2008, China's total debt/GDP ratio was fairly stable and remained below 150%, but it is now about 250%. For that matter, debt across the world in both developed and emerging economies has once again reached new highs, making for a highly leveraged global economy. And as we've seen before, this makes for heightened volatility.
Additionally, as we've mentioned before in these pages, corporations have been doing everything they can to get earnings, from cutting costs as much as possible to avoiding internal investments at all costs. According to the Commerce Department, the average age of fixed assets, such as plants and factories, is about 22 years-old, the oldest average going back to 1956. That doesn't sound to us like a set of solid fundamentals for a high-flying market.
So let's look at what an investor can do given the current market conditions. We mentioned Japan is getting uglier and uglier every day. The country's debt has continued to skyrocket, while growth remains elusive. Meanwhile, their population is aging such that it cannot continue to hold onto its own debt for savings, but will need to cash it in to support their later years. Under the prevailing narrative in global sovereign finance, Japan's only choice is to print, which means the currency will have to depreciate. Investors who look at this as an opportunity may consider going long on gold in terms of yen.
Back in the U.S., we think investors would be well served to get their pencils out and have a shopping list ready for when we have another correction, as most stocks are just too pricey for us now.
One theme we find particularly interesting is the trend towards ubiquitous video -- and we're not talking Netflix (NFLX) this time around. We are looking at Taser International (TASR) for its body-worn video cameras, which police wear on their chests or as sunglasses, and which enable data to be uploaded to a cloud-based, Taser-hosted digital evidence management system from anywhere. The stock is currently priced too richly for our blood, but warrants further examination. We've also heard multiple reports of a jump in firearm permits and that always means taking a look at Smith & Wesson (SWHC) shares.
Yesterday, Versace was on Fox Business with Melissa Francis talking about Urban Outfitters' (URBN) disappointing results, with sales declining 7% in the third quarter, and his concern that holiday sales may not deliver as many are hoping. The thinking has been that the drop in gas prices will spur additional spending, but Versace has pointed out that the estimated $15 a week in savings over an eight-week period doesn't even cover the price of a new iPhone. The savings may be material to a lower-income family, and thus a boon to deep-discount retailers, but immaterial for middle-income and above consumers. Ross Stores (ROST), Wal-Mart (WMT) and Costco (COST), as well as TJX Companies (TJX), with its T.J. Max and Marshalls stores, are likely winners.
As investors shop for anything that isn't priced to perfection in the current market, they might take a look at higher-end athletic apparel company, lululemon athletica (LULU), which is currently down over 45% from its June 2013 highs. The company was a Wall Street darling for some time, with its stock up almost 500% by June 2013 from its mid-2007 IPO. Despite the significant drop, we think there is more downside than upside potential for the shares. Last quarter, same-store sales fell 5%, which is particularly concerning when 40% of its store base is less than three years old. Additionally, the company plans to open a new store in Hong Kong and one in Singapore, which will require substantial costs due to logistic complexities, while single stores can't be expected to improve the company's bottom line that much. That type of expansion when the existing stores back home are struggling indicates to us that leadership doesn't have the right mindset.
As if that wasn't enough, Hawkins, a previous lulu-devotee, has been in her local stores quite a few times over the past year hoping some new threads could spark a return to her previous fitness routine, yet has not bought a thing. The one time she found something she liked, the store didn't have her size in stock. Upon inquiring if there was availability elsewhere, the sales associate told her she was free to shop at other stores and see for herself. If you do a little research, it turns out this is not a unique experience. This is a retail company failing in customer service and product offerings -- a deadly combination.
If we take a look again at the recent movement in the S&P 500 we can see that the current rally is wearing thin. Volatility is on the rise. Volume, which was up significantly during the recent decline, is falling with the index's rise, which is contrary to what we'd like to see on upward movement. When investors are confident, volatility declines and volumes rise as the index goes up. Taking an even bigger step back, we can see that volume has continued to fall while the index rose, jumping up only during downtrends.
We believe that investors would be well served to keep a watchful eye on their holdings as we may be shifting to a "sell the rally mode" vs. "buy the dips."
