Here's Why I'm Seeing The Start Of A 'Good' Stock Market Mania
Cam Hui | Jul 14, 2014 12:35AM ET
Recently, there have been a number of bearish warnings about the equity markets. No doubt there have been signs of froth, but how much frothier can the stock market get? Cutting to the chase, my conclusion is we are seeing the initial stages of a stock market mania and that it will have a lot longer to run. Just as my former colleague
If the distribution is symmetric (top chart), then funds flows are normal. If it is skewed to the left or right, it would indicate either significant flows into either stocks (risk-on) or bonds (risk-off). Late last week, it flipped bullish, indicating funds flow into risky assets. This model does not identify the source of the flows, whether it is retail, institutional or fast money (hedge funds), only that there are significant flows.
The chart below shows the funds flow model signals in the last three years. Buy signals are marked by blue arrows and sell signals are marked by red arrows. The circles indicate a return to a neutral condition, which would indicate a move to cash signal. Overall, it appears that buy signals have performed better than sell signals:
Funds Flow Model signal history
The year-over-year growth rate on the SP 500 slipped to 8.51% from last week’s 8.66%. The y/y growth rate of the forward estimate is still at the higher end of its recent range, and the highest y/y growth rate since 2012.
Recently, I also outlined my concerns that the combination of falling profitability, which affects the numerator in EPS, and declining share buyback plans, which affect the denominator in EPS, are top-down warnings that EPS growth may stall out. That's why I believe that the reports from this Earnings Season is so critical to the short-term equity market outlook as these series of earnings reports will serve as a bottom-up verification of that top-down analysis. That's why the earnings reports will bear watching very carefully.
For now, my inner trader is giving the bull case the benefit of the doubt, but he is keeping his stops tight in case we see a series of negative EPS disappointments and guidance.
Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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