This Is What a Market Top Looks Like

Posted On Dec 11, 2015 By Dave Gonigam

  • A mediocre year for the stock market, a phenomenal year for four stocks
  • History rhymes: The “Four Horsemen” of the dot-com crash and the “FANG” stocks today
  • Stockman on a market turning point next Wednesday… and how to prepare
  • Three sectors to steer clear of as 2015 winds down
  • The FBI pushes Congress to alter Silicon Valley’s “business model”
  • United Airlines’ new free snacks (no thanks)… the outer limits of human life span… why readers keep coming back… and more!

“The stock market is narrowing rapidly,” says David Stockman, “to a dramatically diminishing number of ‘momo’ stocks that are sucking up all of the stock market’s remaining oxygen.”

“Momo” is trader lingo for momentum. So we’re talking about a handful of stocks that continue to go up for no other reason than they’ve been going up for some time.

“This is typical of the final stages of a bubble,” David explains. “And means that these last trains out of the station temporarily carry valuations that are detached from the rest of the market. They are subject to violent deflation when the market finally breaks.

“The markets have been narrowing for nearly a year. If history is any guide, this final run of the ‘Fabulous Few’ always precedes a thundering bust.”

“The market has narrowed to essentially four explosively rising mega-stocks,” David declares.

These too have acquired a catchy name among traders — the FANG stocks. Facebook, Amazon, Netflix, Google. They’ve been on a tear during a year the broad stock market’s gone nowhere…

TheFangStocks

At the start of 2015, their combined market cap was $740 billion. This morning, their combined market cap amounts to $1.175 trillion.

“They have gained $435 billion of market cap, or nearly 60%, during the last 11 months,” says David — “even as their combined earnings for the September 12-month period were up by only 13%. This means that their combined P/E multiple has risen from an already frothy 42 times reported earnings to a wholly implausible and unsustainable 60 times.”

We’ve been here before — barely 15 years ago, in fact.

“In the spring of 2000,” says David, “the Four Horsemen of Microsoft, Dell, Cisco and Intel obfuscated a cratering market under the banner of ‘This time is different.’”

Let’s zero in on Cisco. “At its peak in late March 2000,” David continues, “Cisco was valued at $540 billion, representing a gain of $340 billion, or 170%, from prior year.

“Since it had earned $2.6 billion in the most recent 12-month (LTM) period, its lofty market cap represented a valuation multiple of 210 times.

“Nevertheless, the bullish chorus at the time claimed that Cisco was the monster of the midway. The reason being that it dominated networking gear for the explosively growing Internet and that no one should be troubled by its absurdly high P/E multiple.”

The story was much the same with the other three. “Altogether, the Four Horsemen had levitated the stock market by the stunning sum of $800 billion in the approximate 12 months before the 2000 peak.

“By September 2002, the combined market cap of the Four Horseman had crashed to just $450 billion. Exactly $1.0 trillion of bottled air had come rushing out of the casino.

“The absurdly inflated values of the Four Horsemen in the spring of 2000 looked exactly like the FANG quartet does today,” David concludes.

Facebook sports a price-earnings ratio of 107. Netflix, 307. Amazon, 950. Google looks more “reasonable” at 32… but 90% of its revenue comes from advertising, and that revenue will surely shrink whenever the next recession rolls around.

“When the big market break comes, even the powerhouse quartet known as FANG will suffer a large P/E multiple de-rating,” David concludes, “because that’s what happens when financial bubbles burst.”

David’s convinced the beginning of the end comes next Wednesday.

That’s when the Federal Reserve will likely raise its benchmark fed funds rate after holding it near zero the last seven years.

David believes that move will have the effect pushing an already-sickly economy over the edge. Indeed, “the world economy is actually going to shrink for the first time since the 1930s,” he says.

After a long and storied career in Washington — he was Reagan’s boy-wonder budget director — and later on Wall Street, David went into retirement in 2011. He published a book in 2013, The Great Deformation, and launched his Contra Corner blog last year to expand on the book’s themes.

David is so concerned about events the Fed will set into motion next week that he’s now coming out of retirement — and unveiling a one-of-a-kind investment strategy. It will present you 25 chances to make 300% or better over the next year… while everyday investors watch their portfolios collapse for the third time since 2000.

You can get a glimpse of this strategy during a free online training session. We’ve scheduled it for Monday evening at 9:00 p.m. EST. That’ll give you ample time to begin executing the strategy ahead of the Fed announcement on Wednesday. There’s no obligation that comes with signing up, other than giving us your email address so we’ll set aside enough server capacity to accommodate everyone. Click here to learn more and sign up.

Traders have donned their rally caps this morning — the S&P up a half percent as we write at 2,058.

For the moment, they’re shrugging off oil prices that continue to tumble — a barrel of West Texas Intermediate now below $37. Gold is steady at $1,072.

“The S&P 500 has once again snuck below its 200-day moving average,” says Greg Guenthner of our trading desk.

“So you can expect more skittish trading, more whipsaws — and more investors hanging on the Fed’s every word as next week’s big day draws closer.”

Greg has three big “avoids” for the coming weeks — energy stocks, transportation issues and small caps.

“Small-cap stocks have endured a sharp decline this month,” he says. “While the S&P 500 has dropped about 1.6%, the small-cap Russell 2000 is off by 4.3% in December alone. Now, we’re staring another small-cap breakdown right in the kisser.”

“When the FBI killed capitalism,” quips the civil liberties blogger Marcy Wheeler on Twitter.

Here we go again: The feds say Silicon Valley needs to rethink its “business model.”

We return today to the topic of “end-to-end encryption” — the security technology Apple has built into the current version of iOS and Google has built into the current version of Android. “It means that only the sender and the recipient of a message can unlock it,” explains Andrea Peterson at The Washington Post — “so, basically, only each ‘end’ of the conversation holds the keys.”

That also means it’s impossible for the feds to read intercepted messages. The feds don’t like that, and they’ve been squawking about it for well over a year. The squawking has grown since the attacks in Paris — never mind that the killers used unencrypted text messages to communicate.

The feds want Silicon Valley to build a “back door” into their products so the feds can get access. The problem is that a back door would also let in hackers, foreign governments and so on. “You can’t have a back door in the software because you can’t have a back door that’s only for the good guys,” Apple CEO Tim Cook once explained. Other tech experts have said the feds are expecting a “unicorn.”

But FBI chief James Comey won’t give up: Yesterday, he told credulous senators that “it’s not a technical issue… It’s a business model question. The question we have to ask is: Should they change their business model?”

Oy.

“Virtually all of the senators fawned all over his remarks and pledged to go even farther than the FBI director wanted,” writes a discouraged Trevor Timm from the Freedom of the Press Foundation. “Sen. Dianne Feinstein, ranking member on the powerful Intelligence committee, said she was working on a bill to outlaw such encryption tools…

“Even Comey admitted this type of law wouldn’t stop terrorists from using encryption. After all, they’ve been using encryption for decades, and even now, the top five encrypted applications ISIS supposedly recommends to their followers are either open-source (meaning the code is already all over the Internet), made by companies in other countries or both…

“So basically what the FBI director is proposing,” concludes Mr. Timm, “is that we lower everyone’s security for the applications that are popular with hundreds of millions of people — even if terrorists will still be able to use encryption unimpeded.”

Sounds like a hell of a “business model” to us…

Yay for low energy prices? United Airlines is feeling flush enough to start handing out free snacks next year.

Come next February, snacks will be available for no charge on all of United’s North American and Latin American flights, “including the Caribbean and flights between Honolulu and Guam, according to the airline,” says an ABC News story.

“On flights departing before 9:45 a.m., United will offer passengers a complimentary morning stroopwafel, a Dutch, caramel-filled waffle. Flights taking off after 9:45 a.m. will offer an Asian-style snack mix or a zesty-ranch mix of mini pretzel sticks, Cajun corn sticks and ranch soy nuts.”

Your editor just lost his appetite…

“We have been promised for decades how we will experience longer and better life spans,” a reader writes skeptically after our recent musings about gene editing.

“The Bible limits life to 120 years. You will never go beyond this. Yet you keep promising. Furthermore, you claim that time is the most valuable commodity on Earth. It’s the water, stupid.”

The 5: At the risk of going off track, we saw the news yesterday that U.S. life expectancy has stalled out for the last three years.

The Centers for Disease Control says a child born last year can expect to live to 78 years, 9½ months — the same as the year before, and the year before that.

“It’s not clear why life expectancy has been flat lately,” says The Associated Press, “but suicides and fatal drug overdoses probably are playing a role, experts believe.”

The biggest breakthrough in human life span came during the first half of the 20th century — and that was thanks to lower infant mortality. Between better sanitation, better nutrition, vaccines and antibiotics for the very youngest Americans, average U.S. life expectancy from birth grew from 47 in 1900 to 67 by 1950. Progress has clearly slowed since then.

And even gene editing won’t take us past 120, getting back to the reader’s query. But our friend Juan Enriquez says it will make it possible to live vigorously past 90.

That doesn’t even get us into the possibilities of gene-edited algae that can produce oil. (You think $37-a-barrel oil is cheap?)

Juan tells the story far better than we ever could in his book Evolving Ourselves. You can get a free copy — and our exclusive dossier getting you into the most lucrative life science investments — right here.

“Seems like your disgusted readers who keep coming back,” a reader writes in reply to Tuesday’s mailbag, “are like those drivers who get all ticked off at people on the road slowing down to see an accident — only to stop and gawk themselves.

“They keep coming back because they don’t want to miss anything.”

The 5: Can anyone fault us for trying to give them a reason?

Best regards,

Dave Gonigam
The 5 Min. Forecast

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