We are definitely not trying to call a market top here. But it is hard not to.
The temptation grew strong after this week’s flurry of deals with high prices and leap-of-faith logic. Those came on top of steep stock valuations, rising interest rates and a looming slowdown in earnings growth. The stock market is hitting new highs, but the gains are being driven by a small number of stocks while shares of many companies are down significantly. There are domestic and foreign political risks that threaten to upend still-fragile economic recoveries in many areas.
Let’s start with deals. Last weekend, Comcast (CMCSA) won the bidding for Sky with an offer of $38.8 billion, putting a hefty valuation of 15 times expected 2019 earnings before interest, taxes, depreciation and amortization on the European pay-TV giant, according to MoffettNathanson. On Monday, satellite-radio operator Sirius XM (SIRI) announced it will buy Pandora Media (P) for $3 billion. Sirius made a pricey bet that the money-losing music-streaming service is the key to profitably expanding its business beyond cars.
Then there’s Michael Kors Holdings ’s (KORS) deal to buy Italian fashion house Gianni Versace. Clearly Versace’s brand is valuable, but Kors is paying $2.1 billion for a company that generated €15 million in profit last year. In the inflated debt markets, Blackstone made a splash when it sold $13.5 billion in bonds and loans, one of the biggest deals ever, on terms very favorable to itself to finance its acquisition of a stake in Thomson Reuters ’s data business.
There is also the sheer number of transactions. The value of deals announced globally so far in 2018 comes to $3.1 trillion, according to Dealogic, putting it on pace to equal the record set in 2007—a year that included some of the biggest, and worst, deals in history.
The stock market is also crying top. The cyclically adjusted price-to-earnings ratio popularized by economist Robert Shiller is 33.4. That is its highest level ever outside of the dot-com bubble years, when it reached 44.2, and well above its 2007 high of 27.5. While a lower corporate tax rate and technical shifts in how earnings are reported may excuse a higher Shiller PE, that still seems very rich.
One justification for lofty valuations in recent years has been a view that, with interest rates low, “there is no alternative” place to put money besides stocks. But this so-called TINA trade is less appealing now, with the Federal Reserve raising rates and the 10-year Treasury yield near its highest level in seven years. A slowdown in earnings growth will make stocks even less attractive. Earnings at S&P 500 (.SPX) companies should be up strongly for the rest of the year, driven by a strong economy and the corporate tax cut. In the first quarter, when the tax cut reaches its anniversary, earnings growth is expected to slow to 7.1%.
There may also be trouble lurking below the surface of the market. The S&P 500 is up 9% so far in 2018, but those gains have been driven by a dwindling number of stocks. Indeed, shares of about 200 of the companies in the index are down this year and many of them have entered bear market territory. Narrowing leadership of a rising market can be a worrisome sign since it can indicate that investors betting that a small group of big companies can breeze past problems that are weighing on others. Indeed, Apple and Amazon.com account for about a quarter of the S&P 500’s return this year.
Geopolitical risks feel more worrisome than usual, including: The U.S. trade fight with China, the midterm elections, tensions between Italy’s ruling coalition and European Union officials, weakness in several emerging market economies and Brexit uncertainties.
Do signs of a market top make for a market top? Investors need to be mindful of hindsight bias — the tendency to ascribe signs of trouble after the fact. A lot of people remember how Amazon.com chief executive Jeff Bezos was Time magazine’s person of the year in 1999, right before the dot-com bubble collapsed. Not so many remember Facebook chief executive Mark Zuckerberg’s turn in 2010, when his company was valued at a fraction of what it is worth today. (And how the purchase of Time earlier this month by Salesforce.com co-founder Marc Benioff and his wife Lynne Benioff factors in here is anyone’s guess…)
There are enough bells ringing now that investors should worry that one of them might be the bell that gets rung at the top.
|For more news you can use to help guide your financial life, visit our Insights page.|