The Analysts Weren’t Actually Wrong. Here’s Why…
As the stock market continues moving higher, there are a few points we need to consider.
Let’s look at news, earnings, and how bear markets have started in the past.
First is the news.
Bulls are pointing to the latest employment report. As I mentioned a few days ago, unemployment fell from 14.7% in April to 13.3% in May. This surprised analysts, who expected the unemployment report to rise. Stocks rallied on the news, with the Dow Jones Industrial Average rising more than 3.1%.
But the headlines were wrong.
The report itself is a long document. It begins with a few pages of text summarizing the data and at the bottom of the text are some disclaimers stating that the data is affected by the pandemic and resulting shutdowns.
Many analysts skipped this part of the report. They probably assumed it didn’t say anything important. But at the end of the disclaimer, buried at the bottom of page 6, there was some very important information. I highlighted the most important phrase in that section:
“However, there was also a large number of workers who were classified as employed but absent from work. As was the case in March and April, household survey interviewers were instructed to classify employed persons absent from work due to coronavirus-related business closures as unemployed on temporary layoff. However, it is apparent that not all such workers were so classified. BLS and the Census Bureau are investigating why this misclassification error continues to occur and are taking additional steps to address the issue.
If the workers who were recorded as employed but absent from work due to “other reasons” (over and above the number absent for other reasons in a typical May) had been classified as unemployed on temporary layoff, the overall unemployment rate would have been about 3 percentage points higher than reported (on a not seasonally adjusted basis). However, according to usual practice, the data from the household survey are accepted as recorded. To maintain data integrity, no ad hoc actions are taken to reclassify survey responses.”
Headlines should have read “Unemployment Rises to 16.6%” but the Bureau of Labor Statistics released data that was wrong “to maintain data integrity.”
On Friday, the stock market rallied on an error.
Now, let’s look at earnings.
That rally pushed major market averages to within a few percentage points of their all-time highs. Now, we are about back to where we were in February, except that earnings estimates are lower. The table below summarizes the earnings per share estimates for the companies in the S&P 500 Index.
Traders seem to be ignoring this year and expecting everything to get back to normal fairly quickly… They seem to think that, by the end of next year, earnings will fully recover from the pandemic. That requires a strong economy —and that assumption is on shaky ground.
As we know (but few others seem to understand), unemployment increased in May. The recovery is just now beginning, and there is no real data pointing to strong gains in business.
Earnings estimates for 2021 are most likely too optimistic. Lower earnings imply lower prices. The S&P 500 is already trading at about 20 times next year’s expected earnings. The 10-year average of the price-to-earnings (P/E) ratio is about 15.1. That provides a price target of about 2,476 for the end of 2020.
Fundamentals tell us the stock market is about 14% overvalued based on Friday’s close of 3,193.93 for the S&P 500.
What History Tells Us
Finally, I want to highlight that the current rally looks like the beginning of a bear market based on history.
Notice that the market rallied after an initial decline, in effect giving investors a second chance to get out near the high. This also happened in 1929.
Summing up, we know last week’s rally was based on an error. We know that the stock market is overvalued based on fundamentals. We also know that bear markets consistently provide investors a second chance to get out near the highs.
It seems more likely than not that we should expect a market decline before the end of the month.
But just because there are mounting risks in the stock market doesn’t mean you should be afraid. Instead, you should focus on two things… 1) proven trading strategies that deliver solid profits and 2) massive long-term trends that will come out ahead no matter what the market does in the short-term.
That’s why I’m excited to share my latest “controversial” research with readers…
I wouldn’t blame you if you missed this, but there is a growing movement to decriminalize psilocybin fungi, aka “magic mushrooms.” Yes, you read that correctly. As it turns out, magic mushrooms contain a naturally occurring psychoactive and hallucinogenic compound called psilocybin. This compound has been studied extensively, and researchers have shown they can help ease physical pain, depression, anxiety, chronic headaches, and a host of other ailments.
This is quickly becoming a mainstream for-profit business. And it’s only a matter of time before local governments decriminalize their use (in fact, it’s already happening). My team has been researching the exciting investment opportunities in magic mushrooms. And we’ve pinpointed one company that’s poised to reap the lion’s share of the investment spoils.