September 04, 2013 at 11:08 AM EDT
Dow Jones Industrial Average: 4 Reasons Why The Upward Trend Is Over
INDEXDJX:.DJI, INDEXSP:.INX, NYSEARCA:SPY, NYSEARCA:DIA, DJI:DJI, CBOE:SPX, NQ:COMP, NY:XAX Related posts: Dow Jones Industrial Average and S&P 500: Weakness Remains The Trend 5 Reasons The Dow Jones Industrial Average’s New Highs Are “Bull-o-ney” Dow Jones Industrial Average: Ready For Liquidation? Dow Jones Industrial Average and S&P 500 Hit A Wall; What To Do Now Dow Jones Industrial Average: Why The Easy-Money Markets Will Soon End

bearbull21Bill Hall: I made a prediction on July 24 that the U.S. stock market was poised to fall.

Since then, the Dow Jones Industrial Average (INDEXDJX:.DJI) and the S&P 500 Index (INDEXSP:.INX) are down about 3 percent (as of yesterday morning), even after hitting record highs in early August.

At the time, I warned that for most of 2013, investors had been in a buying mood as Federal Reserve Chairman Ben Bernanke consistently reaffirmed easy-money policies. But as I cautioned, those policies — official interest rates near zero and trillions of dollars in bond buying — can’t go on forever.

Based on recent developments, I have become convinced that early August marked the top of the equity markets for 2013 — the S&P 500 at 1,710.

That’s because P/E multiple expansion, not earnings growth, has fueled the rally in U.S. equities. (That term refers to a situation in which the price-to-earnings, or P/E, ratio rises because investors are increasingly willing to pay more for a dollar of earnings.) In fact, Scott Minerd of Guggenheim Partners reports that while the S&P 500 has increased by more than 34 percent since the beginning of 2011, only 6 percent of that return has come from earnings growth, and the rest from multiple expansion.

Recall that there are only three elements of investment return: P/E multiple change (expansion or contraction), earnings growth and dividend yield, with P/E multiple change being the most volatile and unpredictable factor.

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A rally in stocks driven by multiple expansion, not earnings growth, is likely unsustainable and a market decline seems inevitable.

More alarming is the fact that corporate earnings growth has slowed (instead of accelerated) during that same period, registering the slowest earnings growth in non-recession years since 1998. Without renewed earnings growth, a rally in stocks driven by multiple expansion is likely unsustainable and a market decline seems inevitable.

It’s also interesting to note that this expansion in P/E multiples over the past 2 1/2 years has occurred despite these factors: Questions about the sustainability of growth in China, mounting evidence suggesting that further quantitative easing may be ineffective, a growing lack of confidence in our leaders in Washington D.C., and disappointing revenue and profits in the second quarter.

That means the S&P 500, despite its recent decline, still stands within 4 percentage points of an all-time high because investors have discounted all of this bad news and looked toward the future with optimism.

But I see evidence that this upward trend in the stock market will come to an end.

Below are four reasons why I believe the U.S. stock market has peaked for the year.

1The selection of a new Federal Reserve chairman is a bigger deal than is expected. Whether the ultimate choice is Larry Summers, Donald Kohn, Janet Yellen or perhaps even Tim Geithner, the selection process is going to be bumpy. And a market that is being held together by an easy-money policy can’t take a lot of uncertainty.

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Related posts:

  1. Dow Jones Industrial Average and S&P 500: Weakness Remains The Trend
  2. 5 Reasons The Dow Jones Industrial Average’s New Highs Are “Bull-o-ney”
  3. Dow Jones Industrial Average: Ready For Liquidation?
  4. Dow Jones Industrial Average and S&P 500 Hit A Wall; What To Do Now
  5. Dow Jones Industrial Average: Why The Easy-Money Markets Will Soon End

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