Wall Street continued to set new highs earlier this week.
Fund flow data indicates quite clearly the recent rally in US stocks has been underpinned largely by capital outflows from Europe into the United States and emerging markets after the Brexit vote.
Will the strong rally sustain?
One major uncertainty is whether investors will continue to withdraw money from Europe and funnel it into the US markets.
In fact, there are three worrying signs that do not favor a sustained rally.
First, US corporate earnings have been declining in recent quarters.
The 12-month combined earnings per share of S&P 500 constituent stocks have been falling year on year since the third quarter of 2014.
It’s hard to imagine that stock prices can keep diverging from corporate earnings. The longer this anomaly lasts, the more likely the stock bubble would burst.
Second, the risk appetite of US market investors appears to be declining.
Let’s use the balance of margin financing on the New York Stock Exchange as a gauge. This figure soared to over US$500 billion in April last year, but has dropped to US$447 billion as of the end of June.
Over the last 20 years, this margin debt level usually peaked several months ahead of the US stock market, such as in early 2000 and mid-2007.
If investors are less willing to take out loans to buy stocks, that would naturally reduce the chance for the market to keep scaling new heights.
The third trouble sign is a surge in stock sales from so-called insiders, such as company management, big shareholders and employees.
Such insider selling of S&P 500 constituent stocks reached over US$100 million in the past month, an extremely high level rarely seen in the market.
When the figure hit that level at the end of 2015, the S&P500 index pulled back 10 percent not long afterwards.
This article appeared in the Hong Kong Economic Journal on Aug. 19
Translation by Julie Zhu with additional reporting
[Chinese version 中文版]
– Contact us at [email protected]