The Bear Market Has Just Begun

 

Today the narrow-minded canyons of Wall Street are littered almost entirely of trend-following bulls and cheerleaders who don’t realize how little there is to actually cheer about. Stock values are far less attractive than they were on that day back in 2009 and this selloff has a lot longer to run. There are hordes of perma-bulls calling for a V-shaped recovery in stocks, even after multiple years of nary a downtick.

Here are six reasons why I believe the bear market in the major averages has only just begun:

1) Stocks are overvalued by almost every metric.One of my favorite metrics is the price-to-sales ratio, which shows stock prices in relation to the company’s revenue per share and omits the financial engineering associated with borrowing money to buy back shares for the purpose of boosting EPS growth. For the S&P 500 (INDEX: .SPX), this ratio is currently 1.7, which is far above the mean value of 1.4. The benchmark index is also near record high valuations when measured as a percentage of GDP and in relation to the replacement costs of its companies.

 

2) There is currently a lack of revenue and earnings growth for S&P 500 companies. Second-quarter earnings shrank 0.7 percent, while revenues declined by 3.4 percent from a year earlier, according to FactSet. The Q2 revenue contraction marks the first time the benchmark index’s revenue shrank two quarters in a row since 2009.

S&P 500
SNP3:13PM EST
  • Virtually the entire global economy is either in, or teetering on, a recession. In 2009, China stepped further into a huge stimulus cycle that would eventually lead to the largest misallocation of capital in the history of the modern world. Empty cities don’t build themselves: They require enormous spurious demand of natural resources, which, in turn, leads to excess capacity from resource-producing countries such as Brazil, Australia, Russia, Canada, et al. Now those economies are in recession because China has become debt disabled and is painfully working down that misallocation of capital. And now Japan and the entire European Union appear poised to follow the same fate.

This is causing the rate of inflation to fall according to the Core PCE index. And the CRB Index, which is at the panic lows of early 2009, is corroborating the decreasing rate of inflation.

 

But the bulls on Wall Street would have you believe the cratering price of oil is a good thing because the “gas tax cut” will drive consumer spending – never mind the fact that energy prices are crashing due to crumbling global demand. Nevertheless, there will be no such boost to consumer spending from lower oil prices because consumers are being hurt by a lack of real income growth, huge health-care spending increases and soaring shelter costs.

4) U.S. manufacturing and GDP is headed south. The Dallas Fed’s manufacturing report showed its general activity index fell to -15.8 in August, from an already weak -4.6 reading in July. The oil-fracking industry had been one of the sole bright spots for the US economy since the Great Recession and has been the lead impetus of job creation. However, many Wall Street charlatans contend the United States is immune from deflation and a global slowdown and remain blindly optimistic about a strong second half.

Unfortunately, we are already two-thirds of the way into the third quarter and the Atlanta Fed is predicting GDP will grow at an unimpressive rate of 1.3 percent. Furthermore, the August ISM manufacturing index fell to 51.1, from 52.7, its weakest read in over two years. And while gross domestic product in the second quarter came in at a 3.7 percent annual rate, due in large part to a huge inventory build, gross domestic income increased at an annual rate of only 0.6 percent.

GDP tracks all expenditures on final goods and services produced in the United States and GDI tracks all income received by those who produced that output. These two metrics should be equal because every dollar spent on a good or service flows as income to a household, a firm, or the government. The two numbers will, at times, differ in practice due to measurement errors. However this is a fairly large measurement error and it leads one to wonder if that 0.6 percent GDI number should get a bit more attention.

5) Global trade is currently in freefall. Reuters reported that exports from South Korea dropped nearly 15 percent in August from a year earlier, with shipments to China, the United States and Europe all weaker. U.S. exports of goods and general merchandise are at the lowest level since September of 2011. The latest measurement of $370 billion is down from $408 billion, or -9.46 percent from Q4 2014. And CNBC reported this week that the volume of exports from the Port of Long Beach to China dropped by 10 percent YOY. The metastasizing global slowdown will only continue to exacerbate the plummeting value of U.S. trade.

 

6) The Fed is promising to no longer support the stock market. Back in 2009, our central bank was willing to provide all the wind for the market’s sail. And despite a lackluster 2 percent average annual GDP print since 2010, the stock market doubled in value on the back of zero interest rates and the Federal Reserve ‘s $3.7 trillion money-printing spree. Thus, for the past several years, there has been a huge disparity building between economic fundamentals and the value of stocks.

But now, the end of all monetary accommodations may soon occur, while markets have become massively over-leveraged and overvalued. The end of quantitative easing and a zero interest-rate policy will also coincide with slowing U.S. and global GDP, falling inflation and negative earnings growth. And the Fed will be raising rates and putting more upward pressure on the U.S. dollar while the manufacturing and export sectors are already rolling over.

I am glad Ms. Yellen and Co. appear to have finally assented to removing the safety net from underneath the stock market. Nevertheless, Wall Street may soon learn the baneful lesson that the artificial supports of QE and ZIRP were the only things preventing the unfolding of the greatest bear market in history.

Michael Pento produces the weekly podcast “The Mid-week Reality Check,” is the president and founder of Pento Portfolio Strategies and author of the book “The Coming Bond Market Collapse.”

 

Lumber Liquidators Holdings

LL : NYSE : US$70.42

BUY 
Target: US$100.00

COMPANY DESCRIPTION:
Lumber Liquidators is the largest specialty retailer of hardwood
flooring in the U.S. The company offers premium hardwood
flooring products in a wide variety of domestic and exotic wood,
as well as engineered products, laminates, bamboo, cork, and
accessories. Lumber Liquidators assortment is largely comprised
of proprietary brands including the flagship Bellawood brand.

Consumer & Retail — Specialty Retail
MOMENTUM VANISHES IN Q2 PUSHING OUR ESTIMATES LOWER
Investment recommendation
We are lowering our Q2 EPS estimate from $0.94 to $0.61,
compared with guidance of $0.59-$0.61 and prior consensus of
$0.90. LL reported a Q2 SSS decline of 7.1% on top of +14.9%
versus expectations of +7%. Total customers invoiced declined
5% yr./yr., the steepest decline in three years. LL did not regain
momentum after difficult Q1 weather as we had anticipated, and
management is blaming macroeconomic factors. The 131 stores
impacted by weather experienced a SSS decline of 13%, with
non-impacted stores -2%. We are lowering our FY14 EPS
estimate from $3.35 to $2.70 on SSS -2.5% on top of +15.8% (we
had previously forecast +6.3%). We still project double-digit sales
and EPS growth over the long term, keeping us BUY rated. Given
consecutive quarterly EPS misses and limited near-term visibility,
we think investors will view LL as a show-me stock over the next
few months.
Investment highlights
 An inventory shortfall accounted for $18MM of Q2’s $47MM
revenue downfall versus our estimate. LL expects quality
assurance-related supply-chain issues to resolve in Q3.
 We are reducing our price target from $122 to $100 based on our discounted free cash flow model. This is a long-term target, and reflects our belief that LL’s model of better selection, service, and value should enable it to take market share

Lumber Liquidators Holdings

LL : NYSE : US$99.80
BUY 
Target: US$ 120

COMPANY DESCRIPTION:
Lumber Liquidators is the largest specialty retailer of hardwood flooring in the U.S. The company offers premium hardwood
flooring products in a wide variety of domestic and exotic wood, as well as engineered products, laminates, bamboo, cork, and
accessories. Lumber Liquidators assortment is largely comprised of proprietary brands including the flagship Bellawood brand

SSS MOMENTUM PUSHES OUR H2 EPS ESTIMATES HIGHER
Investment recommendation
Very strong sales results at Home Depot (HD : NYSE : $73.73 |HOLD), and Lowe’s (LOW : NYSE : $45.81 | HOLD) this week
points to a rapid recovery in big-ticket home-improvement purchases. On the heels of LL management’s positive
presentation at the Canaccord Genuity Global Growth Conference on August 14, we believe the company’s improved value
proposition will enable it to grow rapidly in this environment, fueled further by a broader advertising message with an
increased focus on the do-it-for-me customer. The new store

Flooring Project - Stairs Landing in Diagonal
Flooring Project – Stairs Landing in Diagonal (Photo credit: 1Sock)

format is in only 8% of LL’s footprint, and we believe it can drive
20% store-level growth as it ramps.
Investment highlights
We are raising our Q3 EPS estimate by $0.05 to $0.66, in line with consensus. Our Q3 SSS forecast increases from +10% to +15% on top of +12%.
 New distribution centers should improve efficiency and support continued top-line growth and margin expansion. LL
is consolidating one of two east coast DCs into a facility 33% larger, and it will open its first west coast location in
California.
 Incorporating our updated projections into our discounted cash flow model raises our price target from $119 to $120.

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Tricon Capital Group Inc. : U.S. Housing Recovery Focus

rodent of unusual size
rodent of unusual size (Photo credit: JamesCalder)

TCN : TSX : C$6.23
BUY 
Target $ 7.15

COMPANY DESCRIPTION:
Tricon Capital Group Inc. is a leading asset manager focused on investing in North American residential real estate development and single family homes. The company has $1.4 billion of assets under management and investments spread across six active funds and a growing single-family homes segment. Tricon’s investments are focused on four markets in Canada (Toronto, Vancouver, Calgary, and Edmonton) and a number of markets in the U.S. including California, Phoenix, Atlanta, Houston, Charlotte, and South Florida

Tricon Capital Group acquires majority stake in one of its funds. Tricon recently acquired a 68.4% limited partnership co-investment interest in one of its funds, Tricon IX, for US$261 million. The 2008-vintage fund is currently managed by Tricon on behalf of its limited partners seeking exposure to the U.S. housing market. Tricon IX has produced an actual IRR of 10% from inception to the transaction date, an attractive return for fund partners. Following the transaction, management of Tricon is
expecting to achieve an IRR of 15-20% for Tricon IX, boosted by the extension of certain investment opportunities in the fund.
U.S. housing exposure essentially doubles.

On completion of the acquisition, Tricon’s exposure to the recovering U.S. housing market increases substantially, providing additional upside potential from land development and homebuilding as fundamentals improve.
Cash flowing assets should avoid substantial drag. The assets held within Tricon IX were acquired between 2008 and 2012, and most projects are currently generating some cash flow. In contrast, if Tricon were to invest significant capital in early stage development assets, we would expect substantial dilution for a number of years.

Maintaining BUY rating but reducing target price to C$7.15. We continue to value Tricon on a sum-of-the-parts basis. Following the closing of the equity offering and Tricon IX investment, we have reduced our estimate of NAV per share from $7.84, to $7.13 currently. We are reducing our target price from C$7.90 to C$7.15 to reflect the decline in our estimate of NAV per share. Our target price, combined with an annual dividend of $0.24 per share (current yield of 3.9%) implies a 12-
month forecast total return of 19%.

All You Need To Succeed – in 500 pages of Investing Strategy and Selections


Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today's stock market

Available at http://www.amazon.com

Stock Market Magic:

Building Your Apprentice

Millionaire Portfolio

 

 All you need to succeed in today’s stock market [Paperback]

Jack A. Bass (Author)

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All You Need To Succeed – in 500 pages of Investing Strategy and Selections


Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today's stock market

Available at http://www.amazon.com

Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today’s stock market [Paperback]

Jack A. Bass (Author)

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