My System Just Flashed A HUGE Warning Sign For The Market
By Jimmy Butts | August 18, 2017 |

It's on every investor's mind...

"When is this bull market going to end?"

I wish I knew. But I can't predict the future any better than you can.

What I can tell you is that I've been keeping a close eye on a handful of indicators that have historically provided signs of a looming pullback, correction and/or recession -- and they're telling me that we're not quite there yet.

But the cracks are beginning to show...

Back in June, I told readers of my premium Maximum Profit service about how my system can identify underlying trends on Wall Street and in the market. I covered how it spotted the feverish pace of share buybacks, the soaring number of stocks with high nominal prices and, of course, how my system had 60% of our portfolio in cash before the market fell as much as 9% at the beginning of 2016.

This week it flashed something a bit more alarming... Something that flies directly in the face of what all the major financial news outlets are telling us.

You have probably read many headlines that have read something like this:

"Dow closes at record highs as Street cheers strong earnings season." -- CNBC

I even touted the strong earnings beats in my previous issue of Maximum Profit:

Of the 378 companies that have reported earnings so far this quarter, roughly 73% have beat estimates. According to Bank of America, this earnings season has seen "the highest proportion of top and bottom-line beats at this point during earnings season in over five years."

So everything seems to be hunky-dory, right?

According to my system, that doesn't appear to be the case. It's just what Wall Street wants you to believe. Sure, earnings have beat "estimates," but that's exactly what those are: estimates. And who creates those estimates? It's often the same people who have a vested interest in the very companies they are analyzing. And sometimes it's the companies themselves.

In both instances it pays to set a low hurdle that can be leaped over.

I know that this may sound like a conspiracy theory that I'm conjuring up. But if you look at earnings per share (EPS) projections for the S&P 500, you'll see that analysts have lowered EPS guidance to $117.20 per share from $121.09 since the beginning of the year.

Now, to be fair -- estimates aside -- second-quarter earnings so far have shown a 10.1% year-over-year growth, which, if this holds, would mark the second-highest earnings growth for the S&P 500 since 2011.

So if earnings are beating estimates at the highest proportion in years and have grown by double-digits, then what exactly is my system warning?

The short answer is cash flow...

You see, a fundamental aspect of my system looks at something we call "cash flow relative strength" -- and it's showing contradicting data compared with the "great" earnings season we've had so far. This past week -- after a large majority of my holdings reported earnings and beat estimates, I'm starting to see that cash flows are falling dramatically.

Remember, cash flow is the life blood of any company.

Earnings can easily be massaged. But it's hard to manipulate cash flow. It's why I've called it "the most important number in investing." And it's why cash flow relative strength helps form the foundation of the Maximum Profit system.

It was the lack of cash flow growth that my system spotted that helped us move into cash before the market pulled back at the beginning of 2016.

And this past week I've noticed that the cash flow relative strength ratings for many of our Maximum Profit holdings saw a significant drop.

For example, one of our picks reported earnings on August 1 and beat expectations by 10 cents. Two weeks ago, it had a cash flow relative strength (CFRS) rating of 60 two weeks ago. This week its CFRS came in at 24... that's a significant drop. (Note: We use a 100-point scale.)

Could it be that other companies are just growing cash that much faster? Sure, if this happened to just one or two stocks, that could be the case. But when more than one-third of my holdings see a double-digit decrease in CFRS, that tells me there's more to it than just a simple outlier.

Holdings That Have Seen A Significant Decrease In Cash Flow Growth

CompanyCFRS July 28This Week's CFRSPoints Dropped
MP Holding #16024-36
MP Holding #26754-13
MP Holding #38860-28
MP Holding #49821-77
MP Holding #59612-84
MP Holding #67141-30
MP Holding #78759-28
MP Holding #87736-41
MP Holding #97958-21
MP Holding #108252-30
MP Holding #117734-43
MP Holding #128776-11
 
I've left the names of these holdings out of this table out of fairness to my premium subscribers. But as you can see, a number of holdings saw a significant decrease in cash flow growth. 
 
But I didn't stop there. I wanted to see what percentage of stocks in my entire database actually had negative cash flow growth. Astonishingly, 53% of all stocks showed negative cash flow growth -- up from just 34% two weeks ago. 
 
Keep in mind that my system uses a rolling two-year period. This helps ensure that companies are actually growing cash flow as opposed to having one good quarter that skews the growth. 
 
Again, the last time my system indicated a lack of cash flow growth we saw a near 10% drawdown in the S&P 500. 
 
More Signs The Market Is Overvalued
Cash flow growth is only part of the crack that is beginning to show in this bull market. According to Factset, the forward 12-month P/E ratio for the S&P 500 is 17.7, which is higher than the 5-year average of 15.4 and the 10-year average of 14.
 
Not only that, but the cyclically adjusted price-to-earnings ratio, or CAPE, has exceeded the levels of 2008, and is approaching the Great Depression levels in 1929:
 

The point is that stocks are getting expensive, and when they get too expensive, the odds of making money in the stock market aren't good. As I said earlier, I don't believe we're there yet. But when the market finally peaks, my subscribers and I can be glad we're not buy-and-hold investors. We have the Maximum Profit system to let us know exactly when it's time to buy and sell. It's what's led us to some fantastic gains in the past, but perhaps more importantly, it can save us from a drastic downfall.

P. S. Last week, my system flagged five holdings as "sells," but this is far from a bad thing -- one of them has returned nearly 43% in less than a year! 

What's more, the system also flashed a "buy" for two new stocks -- sporting some of the highest Maximum Profit scores we've seen in months.

If you'd like to learn more about the system and get your hands on my latest picks, check out this special report here

This article originally appeared on StreetAuthority.

 

Outbrain