The Grip of a Bear?

10/29/2015 9:00 am EST


Alan Newman

Founder, Crosscurrents Publications, LLC

We have seen a steady outflow totaling $540 billion from domestic mutual funds over the last five years; this implies that this particular mania is institutionally driven, rather than sponsored by the public, asserts Alan Newman, editor of CrossCurrents.

The outflows by the public are outrageous indictments of the metamorphosis of Wall Street from a veritable forum of investment to a circus of short-term trading.

The change into a primarily institutionally driven arena is not entirely without precedent. In 1972, institutional “groupthink” gave us the Nifty-Fifty, an elite class of one-decision stocks.

One study showed that from 1965 to 1972, 18 companies with an average P/E of 47 accounted for virtually all of the S&P’s gains.

The same dynamic exists today, as a relative handful of companies trade at insane valuations, such as Netflix (NFLX) with a forward P/E of 320 and Amazon (AMZN) with a forward P/E of 112.

Adjusted for the effects of inflation, the broad based S&P 500 has gone nowhere for 15 years, whereas margin debt climbed over 51%. And based as it has been on borrowed money, the end is likely to be uglier than expected.

For now, we firmly believe we are in the grip of a new bear market. There will be a lot more pain before we see any gain of note.

Meanwhile, the bank sector looks awful right now. We have focused on this group often and have written a number of times about the potential for a derivative event or events.

The stocks in our tightly focused group include Wells Fargo (WFC), JPMorgan Chase (JPM), Citigroup (C), Bank America (BAC), and Goldman Sachs (GS).

The last four account for roughly 95% of all notional values in derivative products of more than $220 trillion. New lows in this group would indicate expanding odds that a derivative event is in progress.

There is little reason to suspect that the decline is in anything but its early stages. There’s simply no way a heavily leveraged six-year bull market can correct its excesses in only one month.

Mutual fund cash reserves went from 3.5% to 5.9% as stocks bottomed in March 2009 and margin debt was cut by more than half in roughly the same period.

That’s what it’s going to take this time, a sizable expansion in cash reserves for mutual funds and a sizable reduction in margin debt. For now, neither has budged, meaning the bear market has a long, long way to go.

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