Divergences Continue to Send Warning Signals

The chart formation built in the course of the early February sell-off and subsequent rebound continues to look ominous, so we are closely watching the proceedings. There are now numerous new divergences in place that clearly represent a major warning signal for the stock market. For example, here is a chart comparing the SPX to the NDX (Nasdaq 100 Index) and the broad-based NYA (NYSE Composite Index).

The tech sector is always the last one to get the memo – we have dubbed this the “flight to fantasy” – and it is always seen near major market peaks. Incidentally, the Nasdaq was the last index to peak in 1987 as well (the DJIA topped out in late August of that year, the Nasdaq on October 5). So this is a well-worn tradition. The divergences that have been established between these indexes in the recent rebound from the early February are a big red flag in our opinion.

The Urge to Burn Money

As mentioned in the annotations on the chart above, investors are now paying 10 times revenues for more stocks than at any time since early 2000. We discovered the following gem via Jesse Felder’s latest report (well worth reading in its entirety). A few years after the peak of the tech mania, former Sun Microsystems CEO Scott McNealy was interviewed by Bloomberg. He said the following about Sun’s peak valuation in 2000 (it was one of the stocks trading at more than ten times sales at the time):

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”