Reality Check–Historic Divergences

What drives share prices?

Academia and indeed the investment industry per se would have you believe that it’s company earnings or as more often phrased “earnings per share (eps),” despite ample evidence to the contrary that there are periods of time when price goes up as earnings fall and vice-versa.

A technical analyst, who studies chart patterns and uses a tool-box of indicators for guidance, will ignore “eps,” as they can be easily manipulated or distorted, either by way of accountancy shenanigans or via the recent “flavour of the time, share buy-backs.” The following monthly-data chart of the S&P 500 index, America’s finest, includes a blue-line 200 period moving average, a way of smoothing out the return and a line that has offered pretty good “support” to price over the past 16-years. Note however, that IF price moves too far above the blue-line, price has snapped back as during the 2000-2003 and 2007-2009 periods:

24 August 2016 1

The lower green-line is a momentum measure, in this case a rolling 12-month rate of change indicator (ROC.) Again kindly note that, as in 2003, the post 2007/09 financial crash saw the ROC accelerate for just over a year, since when there has been a major divergence, stocks higher whilst the momentum is grinding lower (see red arrow.) Hence, the gap above the 200 blue-line and the green-line divergence are flashing warnings of a major stock-market top approaching.

A Socionomist, who studies collective social mood by way of a nation’s main stock-index, observes that there are periods in history, usually three-generational, when optimism (or complacency) is so high that the “crowd” turn mad, blindly following each others wisdom that, “it’s different this time,” to justify matters such as divergences and other technical observations.

A second chart below shows the same S&P 500 stock-index, compared this time with reported year-on-year earnings per share:

24 August 2016

Here, as stated earlier you can see that stocks have risen during periods of rising and falling EPS so we can kick the academics theory into the long-grass. You may note also, the periodic “major divergences” between the two variables, particularly towards the 2000 and 2007 market tops and also observe that they were trifling when compared to the current market divergence.

This Socionomist and technical analyst observes that based on both charts presented, the divergences are of historic proportion and indeed supports another recent observation in respect of another asset-class, as outlined within, “The Madness of Crowds.”

The warnings are there but only if you can see past the crowd.

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One response to this post.

  1. […] Whether its temporally or otherwise, the near future will surely show, but there is an uncanny S&P target as set out within last week’s comment, “Reality Check – Historic Divergence.” […]

    Reply

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