Reality Sets In

"Life is a series of natural and spontaneous changes.  Don't resist them - that only creates sorrow.  Let reality be reality.  Let things flow naturally forward in whatever way they like." - Lao Tzu

The euphoria that the market experienced after the Federal Reserve announced an increase in rates seems to have evaporated as the market has woken up to reality that the Federal Reserve is no longer providing the support it requires to maintain its unsustainable upward trajectory.  I would therefore not be surprised to see the market take it on the chin to such an extent that the Federal Reserve's idea of gradually raising rates in 2016 is put on ice.  In fact they may even be forced into a retraction of the first increase in rates since the iPhone was introduced!

For long time readers of this blog you will know not to get sucked into thinking that this current drawdown is a buying opportunity.  Keep your powder dry as there will be plenty of opportunity to buy stocks at far cheaper prices than those on offer today.

Beware of the FANGs

The quote today is from the famous cartoon scene in The Jungle Book where Baloo the bear in an effort to save his friend, a human boy named Mowgli, has grabbed Shear Khan the tiger's tail as Shear Khan is running to catch and kill Mowgli.

Buzzie (the vulture): [Flaps and Dizzy (also vultures) have just saved Mowgli] "He's safe now. You can let go, Baloo."

Baloo: "Are you kidding? There's teeth in the other end!"

To me this sums up the current state of the stock market.  While the quote above refers to teeth there is a well known acronym FANG's that is used to describe the four must own stocks that are currently driving the stock market indices higher.  Each letter refer to a stock and for those of you who have missed this the stocks are Facebook, Amazon, Netflix and Google (now know as Alphabet).  These four stocks are masking the poor returns of the majority of the stocks that make up the S&P 500 to such an extent that if you removed their stock returns this year the market would be down considerably. All four of these stocks support P/E ratios well into the hundreds and have an average P/E of over 400 however they are still must have stocks!

At market tops there is a tendency for a very small number of stocks to control the market and unfortunately this is the exact same case today.  For those of you with short memories we have had the Nifty Fifty, the SOX (just 17 stocks) and the Four Horsemen among others.  Each time the market is beholden to a small group of stocks to drive the index higher things become lopsided and tend to topple over.  When you add to this fact the length of the current market run, the fact that the Federal reserve in all likelihood will raise rates in a couple of weeks and global economic weakness it seems to me that 2016 will be the year of the tipping point (if we can make it through December without a massive draw down).

Looking at these four stocks one can see that they are all technology companies.  Three of them produce nothing and one is completely reliant on people to remain social.  Yes they are making a ton of money but so too was IBM in its heyday when Big Blue was the only stock to hold.  Remember 2000 and the must have stocks of Ariba, InfoSpace, Inktomi, Verisign and Veritas Software or one of my favorites PMC Sierra?  Where are these stocks and companies today?  Not that I expect the current FANG stocks to disappear (IBM is still limping along a mere shell of its former self) but when you have an average P/E of over 400 and these are the only stocks holding the market up, something has to give.

In the quote above Baloo gets hit by a branch and the tiger Shear Khan, free from his grips ravages his opponent and while Baloo does not die (it is Disney after all) I expect a similar fate for this market in the not too distant future as there are FANGs on the other end!