Below is a transcript from Monday's Morning Market Hit video above.
Welcome to Shortview Trading. My name is Chris Watling. I’m the CEO and Chief Market Strategist of Longview Economics and Shortview Trading, and this is your Morning Market Hit for Monday, 14th of October. In this video, we want to talk about how you should go about investing in equity index futures on a one- to two-week basis. What factors do you want to think about? What should you consider? What should you take into account as you try and decide whether to go long or short on equity index futures in that one- to two-week swing timeframe?
The first thing to think about before you decide whether to go long or short on equity index futures is the context of the global price action. How are global financial markets trading? What’s the S&P 500 up to? How’s it interacting with the bond market, oil, and gold markets? How are the cross-correlations of global financial assets playing out?
The S&P 500 on Friday closed at another record high: 5,815, up over 21% year to date, and up over 6% since the 1st of July in the second half of this year. It’s really motoring along quite nicely, breaking out of a trading range in the middle of last week, breaking out to the upside. With that strength, it’s moved to an expensive valuation. If you look at the S&P 500 on a forward price-to-earnings ratio using consensus rolling 12-month forward earnings, you’ll see that it’s over 21 times forward earnings. So, it’s a very rich P/E ratio. As the chart shows, it’s only been richer on two occasions in the last 50 or so years. Firstly, in the TMT bubble of the late 1990s through to the early 2000s, when we had a giant bubble in tech, media, and telecoms (TMT), that took the market to an extremely expensive valuation — arguably its most expensive in 150 years. Secondly, during the pandemic, when liquidity was everywhere and the central bank was printing a ton of money, the equity market got more expensive, over 23 times forward earnings, compared to where it is today. So, really, only two times has it been more expensive, and both of those were bubbles.
As you can see from the range on the chart, at times the P/E ratio of the S&P 500 in the last 40–50 years has been below 10. We saw that at the end of the Global Financial Crisis, and also at the beginning of the 1982 to 2000 secular bull market. As the market came out of the ‘70s into the early ‘80s, when Volcker made money very tight in 1982, it had a single-digit P/E ratio, as low as six times when that secular bull market began. So, the range in the P/E ratio is wide, and at the moment, we’re towards the top end of that range.
Of course, the discussion in markets is about American exceptionalism — the American economy, the American political setup, the American institutional structure. America as a country is exceptional — this idea has been going around throughout history, and more recently throughout markets, that America is really the only stock market to be in. And if you look at America compared to European or emerging markets over the last 10 or 15 years, its performance is markedly better, multiples better. It’s really been the only real game in town in the last 10–15 years in terms of major global stock markets.
So, the market’s expensive, and it’s been expensive for a while. That’s probably due to this concept of American exceptionalism, with tech being the main game in town — most of it in the States, and that’s where all the earnings growth has come from.
But does this help you trade markets on a one- to two-week basis, or even a multi-month basis? Of course, the answer is no. If you look at this chart we’re showing you now, it’s a chart of the P/E ratio at the start of the year (January of each year) going back over 100 years on the S&P 500, and plotting it against the following 12 months' return. Each dot represents a P/E ratio at the start of the year, and the next 12 months' return on the S&P 500. What you’ll observe from the chart is that there’s absolutely zero correlation between the P/E ratio and the returns over the next 12 months. In other words, the P/E ratio is of no help whatsoever if you want to trade markets on a one- to two-week timeframe, or even a multi-month timeframe. Indeed, I’d argue that you’ve got to go beyond five years to have confidence in using the P/E ratio to help with your investment decisions. You’ve got to have a five-year-plus time horizon. So, it’s no use whatsoever in the short term.
The question is: what do you use? That’s where our models come into play. Markets in the short term are about fear and greed. You want to buy markets when everyone’s fearful, and you want to sell them when they’re greedy. We have a suite of models — both short-term (which we think of as one to two weeks) and medium-term (which we think of as one to four months), all based on this concept of risk appetite. Is the market greedy, or is it fearful? Is it technically overextended to the upside or downside? Are people hedged or exposed? These are the questions you want to ask on that one- to two-week, or multi-month timeframe.
You want to look at models like our short-term risk appetite scoring system, short-term technical scoring system, or short-term put-to-call ratio. All of these are very useful when thinking about a one- to two-week trade on an equity index future. Blend that with our medium-term models — what are they saying? What are the medium-term risk appetite scoring systems saying? How greedy is the market on that multi-month basis? How overextended is it on that basis? What’s the downside put protection in place when thinking about the medium term?
To cap it off, we like to look at our sell-off indicator. This is an indicator we designed in 2006, and it hasn’t changed since then. It’s based on excessive appetite for risk, measuring when the market has been greedy and stayed greedy for a prolonged period of time. We find we get a signal from this indicator before the majority of meaningful pullbacks. By meaningful, I’m talking about 5–10% or more in the S&P 500, and this indicator is good at that. When it crosses +20, it starts to give a signal, and as you can see from the chart, that’s what it’s doing now.
So how do you blend that short- and medium-term view on the equity market? How do you come up with a one- to two-week trading decision, whether to go long or short, when putting together those short- and medium-term models? That’s what we talk about every day in our daily risk appetite product, and we’d love you to take a trial. Simply click on the link below, and we’ll send it to you for free for a bunch of trading sessions. If you like it, carry on subscribing. If you’re a subscriber, it should be in your inbox around 9:00 a.m. London time every business trading day.
Thank you for listening. That was your Morning Market Hit for Monday, 14th October. Please do follow us on YouTube, simply click the subscribe button, like, and share on social media, or follow us on Twitter, LinkedIn, or Facebook. Thank you for listening, stay safe, and trade well.
FIG 1: S&P500 - closing at a record high...
FIG 2: Expensive valuation – forward PE ratio (S&P500)
FIG 3: US stock market versus other countries stock markets - last 10 to 15 years
FIG 4: PE ratio vs. next 12 months return
FIG 5: Short term risk appetite scoring system
FIG 6: Short term technical scoring system
FIG 7: Medium term risk appetite scoring system
FIG 8: SELL-off indicator