What Stock Market Investors Really Face Ahead

The bear dressed as a bull has done a masterful job at luring more and more investors back into key stock indices.

Data from the Investment Company Institute shows that for the week ended September 18, long-term stock mutual funds had inflows of $3.3 billion. For the week prior, inflows were $5.2 billion. (Source: Investment Company Institute, September 25, 2013.)

Those who are buying stocks now cannot see the losses ahead!

The fundamentals behind the rally in key stock indices continue to deteriorate.

Companies in key stock indices are playing tricks to make their corporate earnings per share look better. They are buying back their own shares; and the more they buy, the better their corporate earnings per share look. In the second quarter of this year, the S&P 500 companies in total bought $122.8 billion worth of their own shares. The stock buyback activity in the second quarter was 24.2% higher than the previous quarter! (Source: FactSet, September 23, 2013.)

The troubles for key stock indices don’t just end here. Look at the chart below. It compares consumer sentiment (green line) and the S&P 500 (red line). Pay close attention to their relationship.

Chart courtesy of www.StockCharts.com

While consumer confidence has basically been flat, the S&P 500 has risen. The theory behind this is that when consumer sentiment is better or increasing, consumers go out and spend. As a result, companies’ corporate earnings increase. This is not the case right now.

Last but not least, we are hearing companies in key stock indices warning about their corporate earnings going forward. So far, 82% of the S&P 500 companies have issued negative guidance about their corporate earnings for the third quarter. How significant is this? The five-year average of S&P 500 companies providing negative guidance about their corporate earnings is 62%. As a whole, the number of companies proving a negative third-quarter outlook, in numbers, makes up almost 18% of the index—or 88 companies. (Source: FactSet, September 20, 2013.)

From my point of view, the disparity between the underlying fundamentals and stock valuations has increased to an unprecedented level. Be very careful with equities; easy money and tricks can only drive key stock indices higher for so long.

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