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
  • 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.”



EAC : NYSE : US$13.80
Target: US$17.00

Erickson Air-Crane is a provider of heavy and medium-lift
air services for government and commercial customers.
Key markets include firefighting, personnel transport,
construction, and oil and gas. The company is the largest
operator, and type certificate holder, of the SH-64
Aircrane. The company is based in Portland, Oregon.

Transportation and Industrials — Aerospace and Defense
Investment recommendation
EAC reported adjusted Q3/14 EPS of $1.22, compared to our estimate of
$0.95 and consensus of $1.01. Cash flow in the quarter was a positive
~$17M. Note that Q3 is usually seasonally the strongest quarter for EAC.
However, the company indicated that full year results would likely be at
the lower end of its guidance range, which was unchanged from prior
quarters. In the Government segment, firefighting revenues were up
12% over Q3/13, while Defense & Security revenues were down 25%
year-over-year. Much of the growth was in Infrastructure (oil and gas)
markets. We continue to see risk associated with the timing of the
commercial market ramp, while revenues in the defense segment
seemed to be declining slighter faster than we had modeled. We are
maintaining our HOLD rating and lowering our price target to $17.
Investment highlights
 The company saw a nice step-up in bill rates across markets.
However, the company indicated that Q4/14 results will drive full
year results at the lower end of the guidance range. We are
maintaining our full-year 2014 $0.46 EPS estimate.
 While there was good cash flow in the quarter, the outlook for 2015
is still about the ramp down in Government revenues, and how fast
they can be replaced by commercial revenues, specifically in oil and
gas. The company did announce a win in Ecuador, which should be
positive for 2015.
We are lowering our price target to $17. Our price target is based on the
average of a 12.0x EPS multiple and a 5.25x EBITDA multiple applied to
our 2015 estimates

Bombardier Inc.

BBD.B : TSX : C$3.50

Target: C$5.50


Bombardier operates in two major and roughly equally sized
segments: 1) aerospace equipment including business jets and
small airliners, and 2) rail equipment. Products are sold and
manufactured on a global basis.
All amounts in C$ unless otherwise noted.

Transportation and Industrials — Airlines and Aerospace
BUY for margin expansion potential, new products
We continue to recommend BUYing Bombardier (BBD) due to 1)
surprisingly good CSeries order flow at the Farnborough air show, 2)
increased focus on improving profitability at Bombardier Aerospace (BA),
and 3) margin improvement potential from the weak Canadian dollar.
BT continues to hold potential
BBD held an investor trip to Europe this week. Key stops included a
meeting with Bombardier Transportation (BT) President, Dr. Lutz Bertling
and plant tours of BT’s largest facility, Henningsdorf, and the Bombardier
Aerospace (BA) CSeries wing plant in Belfast. Takeaways include:
 BT sales growth looks positive. Growth should be in the 5-10% per
year range for the next 3 years, and 3-5% per year thereafter;
 BT still believes 8% EBIT margins are quite possible, which would
be a big pickup from the 6% targeted for 2014;
 The CSeries continues to progress, with production wings moving
through the Belfast plant. Belfast’s composite technology also
appears impressive and proprietary.
Forecast bumped on BT sales discussion; target bumped on forecast
The BT sales guidance was higher than we were projecting, so we
increased our forecast to be in line with the growth rates outlined by
management. Our target increased on our new forecast.
Valuation maintained at a premium level
We are maintaining our valuation multiple at 9.0x EV/NTM EBITDA in
one year (9.0x Q2/15E EV to Q3/15E – Q2/16E EBITDA). Our valuation
remains at a premium level, reflecting the significant EPS growth
potential from BBD’s new product and other opportunities.


T-Mobile US BUY Target Price $39

TMUS : NYSE : US$28.49
Target: US$39.00

The fourth largest wireless carrier in the US by
subscribers, T-Mobile US was established with the merger
between MetroPCS and T-Mobile USA, formerly a unit of
Deutsche Telekom. The company is majority owned by
Deutsche Telekom and is headquartered in Bellevue,
All amounts in US$ unless otherwise noted.

Investment recommendation
Our two-day non-deal roadshow in the Midwest served to solidify our
view that the company’s dynamic, aggressive pricing strategy is
continuing to drive postpaid add share. While the focus on the margin
seems to have shifted from lowering prices as part of the Un-carrier
strategy to offering more data at the same prices with targeted
promotional activity highlighting network quality, strong momentum
continues as evidenced by management’s disclosure earlier this month
of 552k postpaid and 208k prepaid net adds in August alone. These
results suggest upside to our Q3/14 estimates of 580k and 106k,
respectively. Management also discussed a number of key industry
issues, including upcoming spectrum auctions, competitors’ network
build plans and the potential for large-scale M&A. Maintain BUY.
Investment highlights
 More targeted promotions continues to lead the industry in terms of aggressive pricing, the
magnitude of disruption has been lower. Recent promotional activity
– i.e., four lines for $100, slated to end this month – appears to be
more limited, with a longer-term intent to offer more data and
ancillary services at comparable price points.
Network goals – The company has been accumulating low-band
spectrum throughout the year in the secondary market and
discussed the possibility of expanding coverage to 300M POPs. Such
a move, however, would likely be contingent on the results of the
upcoming AWS and broadcast auctions.
 Maintain BUY, $39 target – Management’s aggressive strategy is
enabling market share gains and, though we believe the absence of
a credible, immediate-term acquirer eliminates some M&A upside
potential, we continue to recommend T-Mobile US

Stratasys BUY Target Price $150

SSYS : NASDAQ : US$120.63
Target: US$150.00

Stratasys Ltd. is a global provider of 3D printing solutions,
including a wide range of 3D printers, consumable print
materials and services. Stratsys Ltd. was formed with the
merger of Stratsys and Objet in a stock-for-stock merger
completed in December 2012. The combined company
has an impressive portfolio of 3D printing and direct
digital manufacturing solutions.
All amounts in US$ unless otherwise noted.

Transportation and Industrials — Manufacturing Technology
Investment recommendation
SSYS management laid out a solid case for driving strong top line organic
growth (25%+ over next 3-5 years) during Monday’s analyst day in New
York. Momentum remains healthy at the high end for Fortus and
Connex3, which is likely to yield strong follow-through materials sales
and gross profit, while new product introductions are continuing at a
rapid pace (41 in 2014) and should keep the channel invigorated. The
presentations also clearly illustrated compelling synergies between a
recently expanded service bureau capability (Solid Concepts and Harvest
acquisitions) and strategic sales efforts for hardware and materials that
address the desire of large global customers to explore the full range of
3D printing’s ROI potential in their manufacturing and design activities.
We are reiterating a BUY rating and $150 price target, and see EuroMold
(late November) as a looming positive catalyst for SSYS based on 10+
additional new product introductions to be made during the show.
Investment highlights
 SSYS at the analyst day announced the launch of two new Connex1
and Connex2 printers at lower price points to complement the
Connex3 printer that has strong customer traction. The new printers
add increased functionality and share a common family platform with
Connex3 and replace the Eden Series of Connex printers. Additionally
SSYS announced the launch of the new FDM ASA outdoor material
offering targeted at automotive applications. Management expects to
announce more than 10 new products at EuroMold this November.
 Stratasys reiterated its 2014 guidance for revenue of $750-770M
compared to our estimate of $759.6M and consensus of $758.8M and
EPS of $2.25-2.35 compared to our in-line estimate of $2.31.
Management reiterated a long term revenue target of 25%+ growth
with long term operating margins of 18%-23%.

HEICO Corporation

HEI : NYSE : US$52.05 BUY 
Target: US$65.00

HEICO is a leading provider of commercial aerospace
spare parts and repair services, as well as niche
technology and electronic products for the space,
defense, industrial, medical and other markets. The
company reports its results in two operating segments:
Flight Support Group (FSG) and the Electronic
Technologies Group (ETG).

Transportation and Industrials — Airlines and Aerospace
Investment recommendation
HEI is scheduled to report its Q3/14 results after the market close
on Aug. 26. In our view, sentiment on the stock has turned overly
negative due to concerns about slower growth in the commercial
aerospace market, margin improvement in the defense business,
and valuation. We believe the long-term positive thesis still holds,
and we believe the Q3/14 results will provide a positive catalyst.
We are maintaining our BUY rating and our $65 price target.


Investment highlights
 HEI management has gone out of its way to stress the
difficult Q3/13 comp (up 17% organic growth) in the FSG
segment. The comp Q2/14 results point to ~10% quarter for
FSG, which is in our model. We see the downside of FSG
organic growth as high single-digits. We believe anything
over 10% will be a strong catalyst, but an in-line quarter
(FSG organic growth of 8-10%) will not disappoint investors.
 We expect some ETG margin improvement (we model in
23%) but expect an additional step up in Q4/14.
 We believe HEI will raise its EPS guidance to up ~15%, from
the current 13%, which implies 2014 EPS of $1.76. We are
maintaining our 2014 $1.79 EPS estimate. We do not expect
any increase to the revenue guidance.
Our $65 price target is based on the average of a 32.0x EPS
multiple and a 15.0x EBITDA multiple, applied to our 2015

Stantec Inc.

STN : TSX : C$70.12
Target: C$78.00

Focused on fee-for-service work, Edmonton-based
Stantec plans, designs, and manages projects in the
North American infrastructure and facilities sector. The
company’s business model incorporates diversity across
regions, end markets, and all phases of the infrastructure
life cycle to manage risk and deliver growth. 2013
marked Stantec’s 60th consecutive year of profitability.

Sustainability — Infrastructure

C$78.00 (FROM C$75.00)
Investment recommendation
We are maintaining our BUY rating and increasing our one-year target
price to C$78.00 from C$75.00 following better-than-expected Q2/14
financial results, an increase in our estimates, and as we roll forward
our valuation base by a quarter. We still believe that Stantec’s 5%
targeted organic growth rate for 2014, paired with the strong pick-up in
acquisition activity (closed and announced deals), are supportive of the
company’s long-standing growth targets. In our view, Stantec should
remain a core holding: management has a clear and consistent strategy
and game plan, no lack of opportunities to drive average annual revenue
and earnings growth of ~15% for the foreseeable future, and a long
track record of very disciplined and consistent execution. We also expect
regular annual dividend increases of 10% or more for the foreseeable
We rely on our five-year DCF model (10.5% discount rate) to value
Stantec. Our target price equates to a P/E multiple of 20.0 times and an
adjusted EV/EBITDA multiple of 11.4 times our 2015 estimates. Given
the company’s available growth opportunity and consistent ROE (~18%
level), we view these multiples as supportable, although nearer to the
higher end of the historical range. We are comfortable with this given
current overall momentum, where we are in the cycle, and what we feel
are relatively conservative forward estimates.