The
stock markets have rocketed higher since Trump’s election win on
hopes for big corporate tax cuts. This extreme rally has left
stocks exceedingly overvalued and overbought today. A major selloff
is long overdue and likely imminent. When stocks inevitably roll
over and mean revert lower to rebalance away euphoric sentiment,
gold is the main beneficiary. Gold investment demand soars when
stocks materially slide.
Two
trading days before the November 2016 presidential election, I
published an essay that explored how stock-market action leading
into elections
really sways their results. Its conclusion based on long market
history was “The stock markets overwhelmingly and conclusively
predict Donald Trump will win!” That was a hardcore
contrarian stance before Election Day, when such an upset seemed
impossible to most.
Since Americans voted for our next president, the flagship S&P 500
broad-market stock index (SPX) has soared 28.6% higher in 14.0
months! That extraordinary rally was mostly driven by hopes for big
tax cuts soon with Republicans newly controlling the US government.
And they indeed delivered last month with a massive corporate tax
cut. That sets up a classic buy-the-rumor-sell-the-news
scenario for these record markets.
Ever
since that election, Wall Street has argued that stocks are surging
due to strong corporate-profits growth. But that’s not true
according to hard valuation data. In late October 2016 just before
Americans voted, the 500 companies of the SPX averaged
trailing-twelve-month price-to-earnings ratios of 26.3x. Even
before Trump won, stocks were already very expensive and nearing
dangerous bubble territory.
For
the past century and a quarter, average broad-market TTM P/E ratios
have run 14x earnings. That’s fair value for stock markets, and
twice that at 28x is formally bubble territory. Rather ironically
during his campaign, Trump
often warned
about the stock-market bubble created by the Fed! While he
loves these same stock markets now, they are a lot more expensive
after this past year’s massive taxphoria-fueled rally.
2017
indeed proved a strong year for corporate profits as optimistic
Americans spent money fast. Yet at the end of December a couple
weeks ago, the elite SPX companies were averaging a TTM P/E way up
at 30.7x! That’s well into bubble territory, and history has
proven stock markets never fare well for long after valuations are
bid up to such unsustainable extremes. That guarantees a major
stock selloff looms.
Over
roughly the same post-election span where the SPX blasted up 28.6%,
SPX valuations rose 16.8%. That means about 6/10ths of the rally
was driven by multiple expansion, higher valuations. Only
4/10ths can be attributable to rising corporate earnings, and
even that is suspect. The economic optimism that was unleashed by
the Republican sweep was huge, driving big spending. But that
anomaly won’t last for long.
And
the Republicans’ corporate tax cuts won’t magically rescue stocks.
While good news for the US economy, they won’t do enough to work off
today’s extreme bubble valuations. Wall Street estimates are
generally for 10% corporate-profits growth this year due to
lower taxes. That would merely push the SPX P/E back to 27.6x,
near-bubble levels. Stocks are now way too expensive for corporate
tax cuts to help much!
As
the stock markets surged into the tax-reform bill’s actual passage
in recent months, contrarian traders assumed any stock selling was
being delayed. Why realize big capital gains in 2017 if tax rates
might be significantly lower in 2018? But the stock markets have
blasted even higher so far in January, with no meaningful selling
yet materializing. That has left the SPX extremely overbought
technically, a bearish omen.
In
the first 4 trading days of 2018, the SPX surged another 2.6%
higher. That’s truly an extreme rate of ascent by any standard.
There are about 250 trading days per year, so annualize out these
early-year gains and the SPX is skyrocketing at a 163% yearly rate!
Obviously there’s zero chance 2018 could see such absurd gains.
Ominously such a fast climb looks parabolic for a stock index as
enormous as the SPX.
In
late December the collective market capitalization of those 500 SPX
companies was $24.4t. Such a vast number gives the stock markets
great inertia. So a parabolic surge in the general stock markets
will always be relatively muted. Unlike vastly-smaller assets like
bitcoin, stock markets are far too large to catapult higher in the
terminal phases of bull markets. The SPX’s early-2018 action has
truly been extreme.
The
stock markets are now dangerously overbought, implying a
major selloff is probable and imminent. Overboughtness happens when
stock markets surge too far too fast to be sustainable. There are
many ways to measure overboughtness, but one of the best is looking
at price levels relative to their own key moving averages. Well
over a decade ago I developed
Relativity
Trading to empirically define this state.
200-day moving averages are probably the best price baselines over
time, striking an excellent balance between filtering out daily
noise and following long-term trends in force. A construct I call
the Relative SPX looks at this dominant stock index as a multiple
of its 200dma. It is simply calculated by dividing the SPX by
its underlying 200dma each day. Charting the results over time
yields illuminating trading insights.
In
any trending market, prices tend to meander in well-defined ranges
relative to their 200dmas. When they stretch too far above their
200dmas by their own historical standards, sharp selloffs soon
follow to restore normalcy and rebalance sentiment. This chart
superimposes the SPX itself in blue over the rSPX in red,
highlighting the extreme overboughtness in the stock markets after
early January’s euphoric surge.
The
Relative SPX effectively flattens the SPX’s black 200dma line at
1.00x, and shows where the SPX is trading relative to that 200dma in
perfectly-comparable percentage terms over time. As of this week,
the rSPX soared as high as 1.103x! In other words, the mighty S&P
500 was stretched 10.3% above its key 200dma. Such extremes are
very unusual and never sustainable for long, signaling major
selloffs looming.
Relativity Trading looks at the past five calendar years’ trading
action to define a relative range. For the SPX that now runs from
0.94x to 1.08x. When the SPX falls down near or under 94% of its
200dma, it’s very oversold so a major rally is very likely soon.
But when the SPX climbs up near or over 108% of its 200dma, it’s
very overbought heralding an imminent major selloff. Such fast
price rises simply can’t persist.
This
week’s rSPX levels hit a 4.4-year high, which might not sound too
extreme. But other things need to be taken into consideration when
high rSPX levels are reached. The trajectory of the 200dma is one
of the most important. While 200dmas mostly rise in bull markets,
that’s not always the case. Early in young bull markets 200dmas are
still falling from the preceding bears. 200dmas can also drift
lower in major corrections.
The
last SPX corrections erupted in mid-2015 and early 2016, when the
stock markets fell 12.4% in 3.2 months followed by another 13.3% in
3.3 months. A correction is technically a 10%+ SPX selloff. That
pushed SPX levels low enough for long enough to drag its 200dma
lower for the better part of several quarters. When stocks started
rallying again, the rSPX shot to high levels before the 200dma fully
turned higher.
Most
rSPX extremes are seen early in bull markets or after corrections
when stock prices surge higher before a declining or flat 200dma has
time to catch up. But that certainly isn’t the case this year. The
SPX’s 200dma has been rising sharply ever since Trump won the
election in November 2016. Today’s rSPX extreme is much worse than
it sounds because it’s coming from a high 200dma after a
powerful rally!
Normal healthy bull markets see corrections once a year or so, when
prices fall back to their 200dmas to work off greed and restore
sentiment balance. Today’s SPX would have to drop more than 10%
just to revisit its 200dma, a major selloff by recent standards.
It’s been 1.9 years since the end of the SPX’s last
correction, so the next one is long overdue. Extremely-overbought
conditions like today help birth major corrections.
Considering how far and fast stock markets have rallied, how
euphoric and complacent traders are today, and how extremely
expensive today’s bubble-valued stock markets are, it’s hard to
imagine the overdue and coming major selloff not at least testing
the upper limits of corrections. That portends a selloff that nears
20%, which is probably the best-case scenario for the bulls.
Anything beyond 20% is a new bear market.
And
unfortunately that new-bear scenario is far more likely. As
of this week this SPX bull has rocketed up an extreme 306.7% in 8.8
years, making for the third-largest and second-longest stock bull in
all of US history! Much of those gains were fueled by epic
central-bank easing far beyond anything ever before seen in world
history. This year both the Federal Reserve and European Central
Bank are slamming on the brakes.
The
Fed just started its first-ever
quantitative-tightening campaign in Q4’17 to unwind years and
trillions of dollars of quantitative easing. QT is going to
gradually ramp up in 2018 to a powerful $50b-per-month pace
starting in Q4 this year. Per the Fed’s schedule, it will
effectively destroy $420b of capital in 2018 by letting QE-purchased
bonds roll off its balance sheet. Nothing remotely close has ever
happened before!
On
top of that the ECB just slashed in half its own QE campaign
this month to a €30b monthly pace, with a targeted QE end date of
September. That means ECB QE will collapse from €720b in 2017 to
just €270b in 2018, a radical 5/8ths plunge. Between the Fed’s QT
and ECB’s QE tapering, there will be the equivalent of $950b more
tightening and less easing in 2018 compared to 2017! That’s going
to leave a mark.
The
Fed and ECB will literally
strangle this
stock bull by unwinding and slowing the QE that grew it. And
this isn’t just a 2018 thing. In 2019 the Fed and ECB are on track
to have another $1450b of tightening compared to 2017. So
these stock markets are in real trouble with central-bank liquidity
being pulled regardless of their extreme overvaluations and
overboughtness. 2018 sure ain’t gonna look like 2017 at all!
Bear
markets ultimately tend to cut stock prices in half, literal 50%
losses in the SPX. The
last couple bears
that started in early 2000 and late 2007 saw the SPX drop 49.1% in
2.6 years and 56.8% in 1.4 years! Bear markets are exceedingly
dangerous and not to be trifled with. They also tend to grow in
size in proportion to their preceding bulls, so the next bear should
be bigger than usual after such a massive bull.
A
major stock selloff imminent, whether a serious correction or new
bear, certainly sounds like bad news for investors. But like
everything else in the markets, it offers huge opportunities to
profit for contrarians who see it coming and prepare. A great Bible
verse that applies to the inexorable stock-market cycles is Proverbs
27:12, “The prudent see danger and take refuge, but the simple keep
going and pay the penalty.”
When
stock markets start materially weakening, investors return to
gold. Gold is the ultimate portfolio diversifier because it
tends to move counter to stock markets. Gold is forgotten when
stock markets are high and euphoria and complacency abound. But
once major selloffs inevitably follow major rallies, gold demand
explodes as investors rush to diversify their stock-heavy
portfolios. Gold is effectively the anti-stock trade.
As
you’d imagine with today’s taxphoria-crazed stock markets, gold
investment is really low. One metric to approximate stock
investors’ capital deployed in gold is the ratio between the SPX’s
market cap and the value of the leading GLD SPDR Gold Shares gold
ETF. At the end of December, those 500 elite SPX companies were
collectively worth $24,432.5b. That dwarfs the meager capital now
deployed in GLD shares.
GLD
exited 2017 holding 837.5 metric tons of physical gold bullion in
trust for its shareholders. That was worth just $35.1b at $1302
gold. That means only 0.14% of the stock-market capital invested in
the SPX companies is invested in the world’s leading gold ETF. I’ve
studied the
history of this ratio, and it is usually much higher. From 2009
to 2012 for example, GLD holdings’ value averaged 0.48% of SPX
market cap.
So
there’s no doubt today’s stock investors are radically
underinvested in gold. They couldn’t care less about it when
stocks apparently do nothing but rally indefinitely. But once the
next major stock selloff arrives, gold investment will quickly
return to favor. This chart looks at the SPX and gold over the past
few years. The last major stock-market correction was actually the
catalyst that birthed today’s gold bull!
Mid-2015 was similar to late 2017 in stock-market terms. The SPX
was relentlessly powering to endless new record highs while
volatility was exceptionally low. Like today, stock traders were
excessively bullish and hyper-complacent. It had been a near-record
3.6 years since the last correction, so people foolishly assumed
stock-market cycles had vanished. Yet not even extreme central-bank
easing can eliminate cycles.
That’s because they are ultimately fueled by the herd behavior
of greedy and fearful humans. As long as these powerful warring
emotions drive collective trading decisions, stock-market cycles
will persist. Gold was despised in that record-stock-market
environment, ultimately slumping to a deep 6.1-year secular low late
that year. Gold-futures speculators were deeply afraid of the Fed’s
coming first rate hike
of this cycle.
But
when the stock markets finally started falling again, triggered by
sharp selloffs in the Chinese stock markets, gold rocketed higher.
Stock investors watching their portfolios bleed rushed to get back
some gold exposure to mitigate the stock losses. They flooded back
into gold with a vengeance, catapulting it 29.9% higher in just 6.7
months in essentially the first half of 2016. That gold-bull
uptrend continues today.
In
Q4’15 when gold was largely forgotten and despised, GLD’s holdings
fell 45.0 metric tons or 6.6%. But in Q1’16 after stock markets
corrected sharply, GLD’s holdings soared 176.9t or 27.5% higher!
Gold investment demand turned on a dime, and the trigger was the
last stock-market correction. Stock selloffs driving surging
gold buying is nothing new, so gold will certainly rally again in
and after the next SPX correction.
When
stock investors want gold exposure fast, they naturally turn to
GLD. This gold ETF acts as conduit for the vast pools of
stock-market capital to slosh into and out of gold. GLD’s mission
is to track the gold price. So when stock investors buy GLD shares
at faster rates than gold is rising, this ETF’s price will soon
decouple to the upside and fail its mission. GLD’s managers prevent
this by shunting that buying into gold.
When
GLD-share demand exceeds gold’s own, GLD issues new shares to offset
and absorb the excess. The capital raised from these sales is used
to directly buy more physical gold bullion for GLD to hold in trust
for its shareholders.
Big GLD buying
by American stock investors alone catapulted gold’s price far higher
in Q1’16. That 176.9t surge in GLD’s holdings accounted for 95.2%
of the total jump in world gold demand!
So
if today’s literally-bubble-valued extremely-overbought
hyper-complacent stock markets concern you, start upping your
gold allocation before everyone else does. Since gold rallies
when stock markets sell off, it’s the ultimate portfolio
diversifier. While forgotten when stock markets are high and
euphoric, gold is quickly remembered and returned to once material
stock selloffs inevitably erupt. Early contrarians win big.
In
roughly the first half of 2016 after the last SPX correction, gold
again powered 29.9% higher. Investors could’ve easily played that
in GLD shares. But when gold rallies significantly, the greatest
gains are won in the gold miners’ stocks. Their profits are
really leveraged
to prevailing gold prices, so their stocks tend to amplify gold
gains by 2x to 3x. In roughly the first half of 2016, the leading
gold-stock index soared 182.2% higher!
With
these taxphoria-inflated
stock markets
hyper-risky today, the potential
upside in gold
stocks is huge. This sector is often the only big winner
during major stock-market selloffs, whether just bull corrections or
full-on bear markets. Gold investment demand surges when stock
markets materially sell off, driving gold sharply higher. The great
gold miners’ stocks with superior fundamentals greatly leverage
gold’s gains.
At Zeal we’ve
literally spent tens of thousands of hours researching
individual gold stocks and markets, so we can better decide what to
trade and when. As of the end of Q3, this has resulted in 967 stock
trades recommended in real-time to our newsletter subscribers since
2001. Fighting the crowd to buy low and sell high is very
profitable, as all these trades averaged stellar annualized realized
gains of +19.9%!
The key to this
success is staying informed and being contrarian. That means
buying low before others figure it out, before undervalued gold
stocks soar much higher. An easy way to keep abreast is through our
acclaimed weekly
and monthly
newsletters. They draw on my vast experience, knowledge, wisdom,
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The
bottom line is stock selloffs are great for gold. This leading
alternative investment is ignored when stocks are high. But since
it rallies when stocks weaken, demand soars for portfolio
diversification during material stock selloffs. Gold is ready to
power higher again once these extreme stock markets inevitably roll
over. The next major selloff is imminent given the bubble
valuations and extreme overboughtness today.
Republicans’ new corporate tax cuts are good news for the economy,
but they won’t boost profits anywhere near enough to work off these
dangerous overvaluations. And with the Fed and ECB both engaging in
unprecedented tightening campaigns this year, stock markets face
fierce monetary headwinds. Gold is the best place to take refuge
and grow wealth as normal stock-market cycles finally resume again. | 
