To See Where Stocks Could Be Heading…Watch What the Banks Are Up to

The global stock rebound continues.

After hitting the low point in February, the S&P/ASX 200 index has bounced back. Overall, the index is still down 3% for the year.

But that’s not the extent of it. The past two years have been tough for stocks. As the following chart shows. The Australian share market rallied strongly from mid-2012 through to 2014. Then it went sideways, jumped higher…but it has mostly been in a downtrend since:

Source: Bloomberg

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And, quite frankly, I don’t really see things improving.

For the past eight months I’ve repeatedly warned you about a major market crash I see ahead for the Aussie and world’s markets. I published a report last August, where I highlighted four ‘crash warning’ signs.

Since then, nothing I’ve seen has caused me to change my view. Stocks are still in perilous danger.

And as each day passes, it seems that more news appears to convince me that it’s only a matter of time before stocks take a major tumble. As an example, take this report from Bloomberg:

Banks found a way to please investors when they couldn’t increase revenue: cut pay, fire employees and shut branches.

JPMorgan Chase & Co. and Bank of America Corp. led financial stocks higher this week after the two biggest U.S. lenders reported reductions in first-quarter expenses that beat analysts’ estimates. Costs and the number of employees rose at Wells Fargo & Co., the worst performer Thursday among the largest U.S. banks.

If you run a business, you’ll know that it’s important to keep an eye on costs. But you also know that you can’t run a business purely on cutting costs. Cost cutting is fine if it’s due to efficiencies. But if the only reason to cut costs is because revenue is falling, well, it’s not something to cheer about.

As an investor, I would look at that business and say that the management should spend at least as much time on finding ways to grow revenue again as they are on cutting costs. In fact, in some ways, you could argue that if the business wants to increase revenue, it may have to increase costs.

It may be better off increasing ad spending or hiring new sales staff, to help boost revenue.

A business that’s confident about the future (or foolhardy if the confidence is misplaced) will do that. A business that isn’t confident about the future won’t.

That tells you more than anything about the results from JP Morgan Chase & Co [NYSE:JPM] and Bank of America [NYSE:BAC] than anything else. The market’s short term reaction was to boost the price for both stocks.

That may have been right for now, but in the long term, it likely won’t be so good for either stock if revenues don’t rise.

More cost cutting from the banks

Speaking of banks cutting costs, more from Bloomberg:

Goldman Sachs Group Inc. is embarking on its biggest cost-cutting push in years as it tries to weather a slump in trading and dealmaking, according to two people with knowledge of the effort.

The firm, already expected to report a steep drop in expenses for the first quarter, recently began dismissing more support staff and is increasingly rejecting bankers’ spending on airfare, hotels and entertainment unless it directly serves clients, the people said. For example, the company cut technology workers in London this week, one person said, and some employees in Europe aren’t being permitted to take once-routine trips to other offices in the region, said another. Additional cuts are likely.

When the report talks about a slump in ‘dealmaking’, it’s talking about mergers and acquisition (M&A) activity. The record level of M&A activity last year, and the potential for it to fall this year, was one of my key ‘crash warning’ signs.

If we look at the monthly chart of deals this year and compare them to last year, you’ll see that the slowdown may have begun:

Source: Bloomberg

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The value of deals for January and February this year were higher than the same period last year. But, March 2016, was much less than March 2015. And halfway through April, the total number of deals is barely one-fifth the level of April 2015.

Of course, I’ll admit that M&A deal flows can be erratic. You can’t always compare one month one year with the same month in a prior year. Instead, you have to look at the longer-term trends.

But even there, to me the trend is sideways at best, if not in decline since the middle of last year.

I’ll keep a close watch on how things develop in M&A. I continue to believe that this will be one of the key early warning signs for a major sell-off in stock prices.

Kris Sayce,
Publisher, Markets and Money

Ed note: The above article was originally published in Tactical Wealth.

Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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