There is no strong bull case right now ?>

There is no strong bull case right now

The market has had a decent rally since its recent bottom in February. I’m not convinced that this is light at the end of the tunnel. I remain bearish.

On a wider timeline, from January to the end of April, the S&P 500 is up 1.43% despite domestic equity mutual funds and ETFs having a net outflow of $45.2 billion. I pay attention to investment company fund flows since it can be indicative of institutional allocation rather than retail money. Of course, I’ve seen in my career plenty of irrational behavior among institutions, but that’s another article for another time.

FactSet is reporting that the S&P 500 now has had 4 consecutive quarters of negative year-over-year earnings growth and also 5 consecutive quarters of negative YoY revenue growth. Despite this, the market has been roughly flat over the trailing 12 months.

This isn’t going to be sustainable. In the long run, earnings are what drive stock prices. Buybacks fueled by (at the time) easy credit can only go so far.

The employment situation is also showing signs of weakness. Last week’s report came in under expectations, although a greater concern that I have is that real wages have been essentially flat since 2008, and the participation rate has remained anemic.

Not too surprisingly, one of the main drivers for the negative earnings growth has been in the energy sector. Energy capex, fueled by (at the time) a permissive junk bond market, was responsible for “33% of the total fixed capital expenditures” for the S&P 500 in Q4 2014, according to FactSet. In fairness, capex overall for the index increased. I would note, however, that the two sectors singled out for the increase in capex were telecom and utilities.

These are not growth industries. If this was capex to replace legacy processes with automation, i.e.: reduce headcount and labor expenses, this could be necessary for shareholders but also isn’t exactly a bullish signal for the economy at large. Let’s just be honest for a second: companies like AT&T and Verizon aren’t exactly facing the same competitive forces that a company like Google or Goldman Sachs faces. Often, the AT&Ts and Verizons of the world don’t rock the boat and switch up inefficient processes until they really, really have to.


Here’s another data point: delinquency rates on commercial and industrial loans, as well as delinquency rates on credit cards, are near historic lows. This actually makes me more concerned, not less concerned. Banks don’t make risky loans right after a wave defaults. Banks make risky loans right before defaults.

The TED spread, the spread between 3-month LIBOR and 3-month Treasuries, has started to widen out from 27 basis points 1 year ago, to 42 basis points today. This is the spread between “risk free” credit to the government and credit to top commercial banks, and it is an indicator of perceived risk in the credit market. Tighter spreads mean a healthier market. The spread is still tight relative to historic levels, but I would monitor this closely and see if it becomes a trend. If so, it could be a sign that we’re peaking out on this current credit and business cycle.

Markets move in cycles. The last cycle bottom was in 2008. Prior to that, there was the 2001 tech crash. The US had a brief recession in 1990-1991. It is a huge oversimplification to say “it’s been about 7 to 9 years since the last one, so we’re about due for another”, but there is a cyclicality that can be followed:

  • New investment opportunities present themselves, opening the door to economic growth
  • Credit accelerates this growth; the market rallies and employment grows
  • The investment opportunity is now at a higher valuation and is saturated with competitors
  • Accordingly, investors take more risk try to maintain growth; credit gets overextended
  • Credit is eventually forced to retract, and the economy slows down

Consider that for a good portion of time in 2011-2013, junk bonds for energy E&P companies were issued close to par. Seth Klarman warned about this as a red flag for an overheated market in his classic book Margin of Safety.

Ultimately, these energy companies ended up becoming victims of their own success. They did indeed shift the balance of power from OPEC to North America, but in the process, they also brought oil prices from the $100 range to the $40 range, eating into profits.

I would recommend tilting toward defensive assets and assets that could do well under a strong US dollar. My bearish case might have been different if all of this information that I mentioned also coincided with an equity market drop, but that hasn’t happened. We’ve had a mini-rally since February instead, and the trailing 12 months have been flat. I don’t see this as being priced in yet.

I am actually quite curious if someone has a bull case. If you have a different take, please leave a comment below or send me an email at

Keep hustling,

Alex Cook

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