The US stock market is forming a major market top. Valuation measures, price charts, decelerating earnings in leading tech stocks, broad-based margin deterioration, inflation, rising interest rates, and rising taxes are increasingly weighing on equity valuations. These growing negative factors are balanced against the massive liquidity which has pushed valuations to historically high levels. The red warning lights are flashing. This note will frame today’s stock market risks, which parallel those of the 2000 Technology Bubble, and will highlight investments with attractive valuations and improving earnings prospects that can provide opportunities and safe harbors.

Buffett Indicator and Shiller CAPE:

Warren Buffett and Nobel Laureate — Robert Shiller are two investment giants. Today both the so-called “Buffett Indicator” and Shiller’s Cyclically Adjusted Price Earnings “CAPE” ratio show the US stock market is at all-time high valuations. These two indicators should warn investors to reduce market exposure, eliminate margin borrowing, and prepare for a market environment that is distinctly different than any seen since the 1970s.

The Buffett indicator compares the total valuation of all US stocks to the US Gross Domestic Product. In the adjacent chart, the current ratio is at a record 204%. Historically, when the market cycle turns down, a market valuation compression more than 50% can occur. This is shown during the 1970s and following the 2000 Technology Bubble. Both down cycle periods occurred during a rise in commodity prices.

Shiller’s Cyclically Adjusted Price Earnings “CAPE” ratio indicator shows the stock market at an extreme valuation level above the 1929 market peak and approaching the 2000 Technology Bubble peak. From the 2000 peak, the NASDAQ declined 83%, and the S&P 500 declined 51%. While this market can continue to defy valuation extremes, the significant downside risk from these historic valuation levels argues for a diligent risk management review. This note seeks to illuminate defensive strategies for a cyclical bear market which historically have had a profound financial impact.

The CAPE ratio shows the market’s price to earnings ratio over ten years. The current risk to the stock market’s excessive valuation is that the economy is approaching peak earnings and earnings will decelerate. Today’s market risk is further compounded by the fact that interest rates are artificially depressed from historically low levels and should rise with the post-COVID-19 economic recovery. Rising interest rates will provide a safe alternative to the stock market.

A Short History of Market Peaks and Bottoms:

Below are three major market index charts: the S&P 500 (SPY), the NASDAQ 100 (QQQ), and the MSCI Emerging Market Index (EEM) illustrating contrasting market scenarios. The first scenario is of unsustainable parabolic rises in the S&P 500 and the NASDAQ 100. This is juxtaposed with the second scenario of the Emerging Market Index which shows a multi-year consolidation where more compelling equity values can be found.

The QQQ chart below appears to be on an unsustainable rise. The QQQ has doubled since the March 2020 COVID-19 selloff. Since momentum is a leading factor in quantitative modeling, when the momentum breaks, the QQQ could fall, and the 2000 to 2003 83% decline is a precedent.

The S&P 500 is heavily weighted in technology stocks, 27.6% information technology. Like the QQQ, the S&P 500 has also doubled since the March 2020 low and this rate of appreciation is simply unsustainable. A bear market like the 2000-2003 and 2008-2009 declines are logical market precedents.

Tech has been in a huge bull market. The chart below of top-performing and worst performing sectors suggest that energy stocks should exit their long term bear market and technology stocks are due for a pause.

In the post-2000 Technology Bubble period, investment flows rotated from US growth to emerging growth markets. The EEM exemplifies long-term equity growth at a reasonable growth rate. Emerging markets possess strong demographic growth prospects with low valuations that are now poised to reverse. Emerging markets include China, Taiwan, South Korea, India, Brazil, South Africa, Russia… Many of these countries are poised for decades of growth from reasonable valuations.

The adjacent CAPE ratio chart shows all countries are below the US’s 53% CAPE versus its historical average. Opportunities in the emerging markets are more attractive than in the United States. Select emerging market exposure offers compelling valuation and price action.

Inflation and Market Risks:

Rising inflation will hurt equity valuations. Rising costs such as rent, healthcare costs, wages, and commodity prices will hurt corporate margins. The chart below from Crescat Capital shows that the inflation rate and earnings yield are highly correlated – that means inflation is inversely correlated to the market price-to-earnings multiple. This means that when inflation goes up, price-to-earnings multiples decline, and the market falls. With the S&P 500 at a CAPE of 38, a return to its historic average could lead to a 34.7% downside risk.

The Great Rotation – Inflationary Winners and Losers:

We have entered a reflationary phase. A commodity inflation cycle has started and could persist for several years. This rotation is neatly illustrated with a chart of the Goldman Sachs Commodity Research Bureau Index (GSCRB) versus the S&P 500 index.

The adjacent chart shows how the GSCRB/SPY ratio rose from 0.10 to 0.70 from 1999 until 2008 — a period of 700% of commodity outperformance versus the S&P 500. This ratio is turning up with rising commodity prices and portends a commodity reflationary cycle of several years and potentially massive commodity cyclical outperformance.

The commodity reflationary/inflationary cycle is now unfolding and shown in the Commodities to Stock ratio chart below.

  • Tech Weakening

The FAANG and QQQ stocks, which have enjoyed extraordinary returns during the deflationary period since 2009, will see valuation pressures from rising interest rates and declining margins in a reflationary environment. Rising wages, commodity prices, and supply chain disruptions are creating a multi-pronged inflationary push that, in the absence of monetary discipline, is proving to be a fertile environment for inflation well over the “transitory” Federal Reserve talking point.

Further, Amazon’s conference call laid plain an anticipated revenue deceleration which will pressure this technology giant’s lofty 36 times forward earnings valuation. AMZN’s revenue growth was 20% before COVID-19, accelerated to the 35-45% range and now are declining “as vaccines become more readily available in many countries and people are getting out of their homes.”

Amazon’s slowing revenue and earnings growth:

The chart above shows the COVID-19 induced revenue growth spurt.

The chart above shows the significant earnings deceleration for Amazon. A 2/3rds deceleration in earnings was a firm sell signal according to William J. O’Neil’s trading rules. With Amazon, we see deceleration and sell signals coming.

The Amazon conference call above explains that the “stay at home trade” which helped Amazon [and other big tech] is ending and traditional “reopening trades” like travel, leisure and energy should experience an earnings ramp which should benefit from this rotation.

  • More Risks for Big Tech:

Senator Josh Hawley’s book, The Tyranny of Big Tech, lays plain the monopolistic position of big tech companies like Facebook, Inc., Alphabet, Inc. aka “Google”, and Apple Inc. He further details their grip on the market and increasingly close alignment with the federal government which parallels the monopolistic robber baron period of the late 19th century. Antitrust legislation followed the robber barons and loosened their lethal grip on the American worker.

Hawley writes that of those using social media, 99% use Facebook, comprising 70% of all adults in the country. Google performs 9 out of 10 searches and its Android smartphone has 85% market share. Amazon Prime has 126 million users. Apple’s App Store generates $500 billion annually in commerce. Big techs control is becoming a growing source of antitrust and anticompetitive litigation. These massively dominant positions will cause the law of large numbers to limit the high earnings and revenue growth that has made these companies world leaders and massively rewarding investments.

Historically, when growth stock earnings slow, growth stock price-to-earnings multiples contract, and their share prices decline with their multiple contractions. Our fear is that, as selling begets more selling, these big tech stocks will succumb to a negative feedback loop of selling. Then momentum and index investors will turn from buyers to sellers. As information technology has a 27.6% share of the S&P 500, a period of technology weakness will induce the same negative feedback loop of selling in the S&P 500 where momentum and index investors could also reverse from buyers to sellers.

  • Commodity Upside:

On the flip side to contracting earnings and margins that are unfolding in tech stocks, we see upside opportunity in commodity stocks. We like natural gas stocks, steel stocks, metallurgical coal stocks, and select energy stocks. Due to the economic cyclicality of these stocks, as the economy recovers, we expect improving earnings trends. Further, commodity cyclical stocks should have considerable operating leverage as commodity prices are rising which allows these companies to enjoy both rising demand and rising prices.

  • Natural Gas:

This week, Charif Souki, the CEO of Tellurian, Inc. (TELL), explained that the IEA reported that global electricity demand is growing faster than the supply of renewable energy. This clearly fits our thesis that natural gas demand will be a winner in the energy space as clean fossil fuel is both replacing coal and oil and filling the demand gap from renewables.

Tellurian also announced a contract with Shell Energy, which should give them the capacity to secure financing for their Driftwood project. During the announcement Shell Energy EVP Steve Hill said “LNG demand is expected to nearly double by 2040” affirming our bullish view on natural gas and LNG. This Shell Energy deal offsets recent uncertainty from the TotalEnergies, SE cancellation, which we used as a buying opportunity. Tellurian estimates $6.6 billion per year in EBITDA based on its completed 5 plants and 27.6 MTPA project plan. In the last 10 weeks, Tellurian has secured agreements with Gunvor Group, Vitol, and Shell Energy for a total of 9 MTPA. Given Tellurian’s current $1.6 billion market capitalization, and the experience of CEO Souki, who co-founded and was the CEO of Cheniere, we are quite optimistic about TELL.

This week, US LNG prices were $4/mmbtu and $14/mmbtu in Japan. With strong demand from Japan and China, we see significant upside for TELL over the next several years which matches nicely with our commodity thesis.

Antero Resources, Inc. (AR) and Antero Midstream, Inc. (AM) reported strong earnings this past week. Their Utica and Permian Basin locations combined with their industry-leading low-cost production, continue to deliver solid earnings which have made these stocks top holdings for our clients.

  • Steel and Metallurgical Coal:

Steel prices, like other commodities, have been on a tear this year. Because global demand should rise with the global economic recovery, steel stocks should enjoy higher prices, higher margins, and higher profits in the next two years. Two steel stocks we like are US Steel (X) and Cleveland Cliffs (CLF). We provided a link to reports by KCI Research on which also identified the Antero investments last year — when some questioned Antero Resources’ viability and the energy sector was in a severe decline.

The chart below shows steel prices at record highs, which implies that future earnings should also rise meaningfully. Consensus earnings for US Steel are $10.28/share for 2021 and continued earnings growth in 2022 is expected by KCI. With a closing price of $26.48/share of X, we expect to see a higher stock price if steel prices continue to surprise the upside.

Source: KCI Research and

Like US Steel, Cleveland Cliff’s (CLF) has enormous operating leverage and earnings momentum. CLF’s 2021 EBITDA guidance has risen from $3.5 billion to $5.5 billion since April. The company expects to pay down all of its $5.4 billion in debt in 2022, and just retired a $1.2 billion preferred.

One special situation is in metallurgical coal, specialty coal needed in manufacturing steel. If demand for steel remains strong, demand for “met” coal should be enormous. Warrior Met Coal (HCC), an Alabama-based coal company offers unique upside potential. HCC was also positioned to pay down its debt in May when premium met coal was $100 per ton, today it is $222/ton according to KCI. This doubling of the met coal sales price should drive significant upside to its earnings. Unfortunately, the company is coping with a strike; however, with higher prices and strong earnings, a resolution of union wages should be resolved soon. With earnings due out August 4th, HCC is another commodity cyclical we like as a commodity inflation beneficiary.


The market is at great risk despite the flood of monetary stimulus that has created an unprecedented cushion to stock prices. With the economic recovery now firmly in place, peak earnings are now priced into the market. A significant slowdown in the GDP growth rate from q2’s 6.5% to 2.5% in 2022 is being forecast by Goldman Sachs. Inflation is poised to crimp earnings but could help certain commodity cyclicals including energy and steel.

With the preferred valuation metrics of Warren Buffett and Robert Shiller are at historically record levels, assuming this period is like the roaring 1920s would be a dangerous miscalculation. We expect a rocky second half and a 10% correction would be quite reasonable. However, long-term trends could prove far worse if inflation presses above the 2% range and market multiples collapse due to margin pressures and decelerating earnings like those from big tech.

There are markets and investments where earnings and valuations should grow in the years ahead. Like the 2000-2003 bear market, we expect money will rotate into commodity cyclical, small-cap stocks, precious metals, and emerging markets while the SPY and QQQ suffer meaningful downside.

These slow summer days are an excellent time for diligent risk management and investment review.

We welcome your thoughts and comments at this dangerous time.


Tyson Halsey