Record High Insider Selling Marks The Top In The Stock Market

There are several indicators today, marking a major top in the stock market. One of those indicators is the overvaluation in the stock market according to the “Warren Buffett Valuation” of the total U.S. stock market index as compared to U.S. GNP. We found out that stock markets are overvalued today, because the total U.S. stock market index is at 100% of  U.S. GNP. Normally we see that the total U.S. stock market index is at 80% of GNP. We just recently had news that U.S. GDP was negative and I wrote about it here. When GDP declines, it inherently means that the stock market must decline, taking into account the Warren Buffett Valuation theory.

Investors are much too bullish on stocks at this moment and we can see that in the Dow-Gold ratio, which is hitting a ratio of 9 to 1 as we speak.

I believe though, we shouldn’t be so complacent about stocks. After all, the P/E ratio of the Dow Industrials stands at 15.3 right now, while in the 70’s, the P/E ratio was on average at 10, which is much lower than 15.3. The question is: “Do we expect higher or lower earnings in the future?”. I believe the earnings are going to get worse in the future. One way to measure this is to look at the Citigroup Economic Surprise Index (CESI). This index is defined as weighted historical standard deviations of data “surprises”. In human language it means that if the index turns negative, the chance of an “unexpected” downward revision goes up. You will hear more bad news out of the media. And what do you know, the CESI did turn negative in the previous month. So you can expect more bad news coming. Historically, when the CESI goes down, the stock market goes down a few months later as you can see on chart 1.

Chart 1: Citigroup Surprise Index Vs. S&P

To read more evidence on a top in equities, go here.

Spain is following Greece in its path to bankruptcy

The situation in Spain is looking worse every day. I believe Spain is following the path of Greece into bankruptcy.

Let’s take a look at the Spanish bond yields. At the end of 2011 we got the massive ECB bailout package named Long Term Refinancing Operation (LTRO). This relieved the bonds of certain peripheral governments like Italy, Greece and Spain. Lately though, with many Spanish regions on the verge of bankruptcy, Spanish bond yields are rising again. Let’s take a quick look at these.

The best way to look at stress in the bond yields is to look at the bond spread between long term maturities (Chart 1) versus short term maturities (Chart 2). If the spread narrows, it means there is stress, because the shorter maturity is about to rise above the longer maturity bond yield. Normally in a healthy economy, longer maturities always have higher yields than shorter maturities. If this is not the case, this means that defaults are looming (see Greece bond yields: shorter maturities have higher yields than longer maturities).

To read the analysis go HERE.

Chart 1: Spanish 10 year bonds

Chart 2: Spanish 2 year bonds