Chasing Waterfalls

The market has fallen into a pattern since peaking exactly one year ago on May 20, 2015. It grinds sideways in a gradually declining trend for a couple of months, then it heads quickly lower over a waterfall, it spends about a month working to get its footing, then it rallies its way back higher for a month or two. Over the past month, we have been grinding sideways in a gradually declining trend. If this recent pattern holds, the next stock market waterfall may be right around the next bend.

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No, Earnings Are Not Beating Expectations

First-quarter earnings season is off to a solid start. Or so you might understandably believe, depending on what analyst you may be hearing or reading. A common refrain in recent days is that “First-quarter earnings seasons have turned out to be better than expected so far”. Hardly ever are these statements challenged with the follow-up questions of “Exactly how?” and “What actual data support this conclusion?” For in reality, first-quarter earnings have NOT turned out better than expected, at least so far. In fact, the results have been markedly worse than what was expected at the end of the first quarter.

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Did The Old Secular Bull Ever Die?

It is a consensus view even among the most bullish investors in capital markets that stocks entered a secular bear market with the bursting of the technology bubble in 2000. Instead, the debate among the bulls and the bears that follow secular market patterns focused on whether the latest secular bear market ended with the market bottom back in March 2009 (the bulls) or remains ongoing through today (the bears). While I have long been firmly in the bear camp on this debate, another perspective that has been largely overlooked may also merit consideration. In a lurch beyond the most bullish of the bulls, what if in fact the most recent secular bear market never happened at all? What if instead the secular bull market that began in 1982 never ended and remains very much intact to this day? If this is indeed the case, what might this mean for capital markets going forward?

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How Far Will Stocks Fall?

Stocks neither rise nor fall in a straight line. Instead, when stocks are rising, they are expected to retrace a portion of their prior advance. Conversely, when stocks are falling, they are expected to retrace a portion of their prior decline. Evidence of this phenomenon are found throughout capital markets over time. But this natural force has been largely missing from the stock market over the past several years. Knowing that the laws of nature have not been repealed despite the best efforts of global policymakers, what does this imply for stock prices once the need to retrace a portion of their prior advance finally returns?

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The Valuation Conundrum

The stock market has a weight problem. The rise from the post financial crisis lows of March 2009 has been remarkable. And more recently, the continued resilience of a stock market that has already set the mark for the third longest bull run in history has been equally impressive. But the growing problem for the U.S. stock market as we move further into 2016 is that it is increasingly lacking any substance behind its latest advance. For if investors ultimately decide that they do not wish to pay more and more for each dollar of declining earnings, the market may eventually find itself in for an unsettling slide to the downside.

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