Whither and whence the stock market?

April 14, 2010Jon Brooks Comments Off

“Unless you’re in the habit of buying new highs, the ascent of this market has been way less enjoyable over the last 6 weeks than the headlines would lead outsiders to believe.”

bullmarketWe are heading into the home stretch here at EconomyBeat — the project concludes at the end of April. Thus, this will be our last post on the stock market. Last fall, with stocks enjoying a half-year’s worth of gains, we asked if a September swoon was in the cards. A bullish month later, we wondered if an October apocalypse might prove the market’s undoing. Then, nearing November, we posted a warning from stock guru Jeremy Grantham on a coming correction.

Yep. Wrong, wrong, and wrong. We’re at Dow 11,000, S&P 1200, and Nasdaq 2500 (any moment now). With the bulls running free and the bears still in hibernation, is it as simple as happy days are here again?

Not really. Last week, New York Times columnist Floyd Norris wrote about the lingering pessimism in the face of mounting evidence that the country is experiencing an economic recovery.

The American economy appears to be in a cyclical recovery that is gaining strength. Firms have begun to hire and consumer spending seems to be accelerating.

That is what usually happens after particularly sharp recessions, so it is surprising that many commentators, whether economists or politicians, seem to doubt that such a thing could possibly be happening.

Regarding the stock market, he wrote:

The stock market’s recent performance may be sending a similar message. Prices have been rising, but there is not much volume. Why? A lot of money managers are fully invested, but many investors remain fearful and are not putting cash into mutual funds. To judge from anecdotal evidence, some of the buying now is short-covering by hedge funds that expected the economy to be much weaker than it is, and thought corporate earnings reports would devastate investors. Instead, they are hearing from companies that business is stronger than expected.

Which means a lot of people who pulled their money out of the market in the heart of the crisis have missed out on some big gains over the past year. Which is understandable — once bitten, twice shy; twice bitten (remember the dot-com bust just 10 years ago?), stock up on food, bottled water, and ammunition.

Here are some random opinions from various stock sites about whither and whence the stock market is headed. (Disclaimer: Predicting the future is only possible when using a time machine, which is expensive.)

Prudent Bear: Botox Economy

by Satyajit Das

Stock prices assume a rapid recovery in corporate earnings. Beating much reduced expectations and a return to previous earnings levels are easily confused.

The “E” in the P/E ratio remains difficult to forecast. Equity pricing assumes a return to 2006 levels when U.S. corporate earnings represented a record share of profits in GDP.

In 2009, full year earning per share for the S&P 500 were around $60, down from $65 in 2008 and 30% below peak earnings of $85 recorded in 2006. In 2009, company results reflected the effects of aggressive cost cutting and the benefits of government support. To return to pre-crisis levels and rates of growth, improvements in revenue and underlying demand are necessary.

Stocks are also not cheap. Jeremy Grantham, founder of Boston-based fund manager GMO, recently noted ruefully that after 20 years of more or less permanent overpricing of the S&P 500, the market saw just five months of underpricing after the March 2009 trough.

Investment Watch: P/E Ratios Set tO Rise in Q4 Through 2010

Aug. 2009 – The New Normal theory states that the recovery will be long and hard with GDP at 1.5 – 2.0 for possibly a decade.

If true, Earnings will bump along at a similar pace and will not recover to the high Earnings before the recession. So now we have low Earnings.

Why should the Price part of the P/E ratio rise?

Simple. Once investors that have nearly a trillion dollars earning nothing in money market funds come to accept this new low Earnings rate, they will decide to jump into the market because it is the lesser of two evils. This will bid up the price of stocks based simply on greater demand, not greater performance.

So now you have a new LOW Earnings number and a new HIGHER Price number and the new P/E ratios will jump higher than before the recession.

Again, this will not signify a higher expectation of future earnings as in the past, but instead, will reflect the New Normal of low growth, high unemployment and a long drawn out 5 years of debt defaults in credit cards, commercial loans, and housing mortgages which will force the further consolidation of the banking industry.

WHAT THIS MEANS TODAY IS THAT YOU CAN INVEST IN JUST ABOUT ANYTHING AND YOU WILL SEE A GAIN IN YOUR POSITIONS JUST BECAUSE OF THE NEW MONEY POURING BACK INTO THE MARKET.

The Reformed Broker: Vacillating Bulls and Dogmatic Bears

To complement the slow but persistent grinding higher of the major stock market indices, we’ve now got two new groups of market commentators – the Vacillating Bulls and the Dogmatic Bears.

I’m trying very hard to tune out both camps at this juncture in an effort to hear what the market is telling me. It is not easy, they are everywhere.

The vacillating bulls are predominantly coming from the the asset management/fund complex and they are typically those who have been underinvested or too risk averse. Their public proclamations of “why fight it” and “ok, NOW I’ve finally gotten the economic confirmation I’ve been waiting for” are a distraction. I do not view their recent prominence in the mainstream press as a market positive, their utterances smack of capitulation.

The dogmatic bears are less threatening to the market’s rise than the neo-bulls are, because they are basically repeating themselves ad nauseum at this point and very little of their dogma is any different from what it was a year ago and even two years ago. Their missives are laden with more dropping shoes than the closet of Imelda Marcos in an earthquake. Yawn.

The vacillating bulls should spare themselves these embarrassing media appearances, they are not “furthering their brands” as they say in PR Speak. The dogmatic bears should likewise cease their spewage and rethink a few of the tentpoles of their argument – to continue the rhetoric against the backdrop of comps turning positive across most surveys would at this point cross over into slapstick territory.

It is one thing to change your mind or stick to your guns, it is quite another to become a public spectacle while doing so.

The Reformed Broker: Hypselotimophobia – The Fear of High Prices

f you are uncomfortable buying or trading stocks that are at new highs, this is not your tape.

There are only two categories of investors who are unfazed by the deluge of new 52 week highs – the nimble and the desperate.

The nimble are in a position to act quickly should things change. With every tick, they are tossing blades of grass into the wind to gauge direction in real-time. If you run a machine shop or have a waiting room full of patients, this is not feasible.

The desperate are most likely professional runners of money, those without the luxury of waiting for their pitch. They must get more stocks on the books to show that they “didn’t miss it” and they must do so regardless of the top-tick risk. An ill-timed buy today can quickly be described as an “intermediate-term” pick to the investment committee if need be, but a swollen cash position in a vortex of up stocks cannot be explained at all.

There’s a bumper crop of gaps and breakouts, hundreds of 52 week highs daily – so why isn’t everybody happy?

Most market participants are not incredibly nimble nor are they under career pressure to buy at any price. The drumbeat of daily new highs can be more frustrating than fun for them.

Unless you’re in the habit of buying new highs, the ascent of this market has been way less enjoyable over the last 6 weeks than the headlines would lead outsiders to believe.

If you are a a hypselotimophobe, there isn’t much for you to do at this juncture, so maybe you want to just chill out.

The Pragmatic Capitalist: Morgan Stanley: This Is Not the Utopia Investors Are Pricing In

MS is one of the few big banks that isn’t buying into the utopian environment for equities. In fact, they believe equity investors are ignoring several risks here – primarily the global tightening that is occurring. They were one of the few banks that actually issued a bearish fiscal 2010 outlook and have remained skeptical of the rally thus far.

Morgan’s analysts believe the equity market is pricing in a permanent utopia for risk assets – a period of high growth with permanently low rates, but in reality, they say the Fed is ready to start altering their accommodative approach:

“Clearly the markets are in a utopia-type environment; with the Fed seemingly on perma-hold and upside in growth… We are on the other side of those views. As we see it, strong growth will ultimately be met with withdrawal of liquidity, and the risk markets will not like that medicine.”

MS says equities could be at risk of substantial declines should the tide shift from the “rates on hold” camp to the “rate hikes” camp. With the VIX falling to its lowest level since Summer 2007 it certainly appears like investors are complacent and pricing in a utopian environment. Unhedged investors might find themselves in their own personal hell if an unforeseen risk should creep into the equity markets.

Slope of Hope

Signs of extreme bullishness abound, whether in the plummeting VIX, net long speculative interest in the Nasdaq, put call ratios, bullish percentage indices, new highs, Dow 11000 hoopla, the Newsweek cover story on the Comeback Country, the $SLIX indicator, they almost got Art Cashin to capitulate on CNBC et. al. Someday, maybe soon, this will reverse direction, but who knows if there will be any bears left to see it happen. One measure of declining bearishness is seen in short interest…The upshot — the wall of worry represented by shorts is a smoldering pile. To be short has been to be annihilated. It is within living memory when all these values were much higher, and ETFs were often hard to borrow. Will this evacuation of standing shorts accelerate the speed of the decline should it ever happen? Stands to reason, but reason is not leading the charge right now…

Financial Sense: Sovereign Debt Disaster Will Favor Hard Assets

by Justice Litle

Last week, in “How to Protect Against Currency Collapse,” we talked about the mounting debt problem and how Western governments will deal with it. If the debt is issued in your own currency, you ultimately just print more currency to inflate that debt away. (If the debt is issued in someone else’s currency, you are in deep trouble… as Greece, Latvia, Iceland and others have all found out.)

Right now the global economic recovery has the appearance of being cost-free. This is due to an age-old confidence trick known as “ignoring the bill.” To pull off this trick, you spend huge amounts of money on a high-limit credit card… ignore the mail when the bill comes due… and conveniently forget to reconcile your accounts.

Complacency reigns because the true costs are not being tallied. The Bank for International Settlements – an age-old central banking watchdog based in Switzerland – is having none of it.

The “simmering fiscal problem” of sovereign debt is set to bring industrial economies “to the boiling point,” the BIS reports in a new study. “Bond traders are notoriously short-sighted,” the BIS further scolds, “assuming they can get out before the storm hits… the question is when markets will start putting pressure on governments, not if.”

The Bank of International Settlements further believes that, if we do not turn from this path, inflation will spiral out of control. “Monetary policy may ultimately become impotent to control inflation,” the BIS scowls, “regardless of the fighting credentials of the central bank…”

Where Have You Gone, Joe DiMaggio?

Try as they might, investors will not be able to ignore the sovereign debt problem forever. When the reckoning comes due, the printing presses will kick into hyperdrive… and faith in the system will crumble (or perhaps shatter like brittle glass).

At this point, investors will turn their lonely eyes to hard assets, looking at precious metals and basic building-block commodities in a new light.

Up till now, hard assets have more or less been treated as a “hot money” play on global economic recovery. Price movements have been linked to speculative appetite and the general degree of optimism.

The onset of a sovereign debt panic could thus lead to a short, sharp and temporary drop in hard asset prices, as the “hot money” beats a hasty retreat. But over time, a post-crisis shift in psychology will occur. In a world where all major currencies are being debased, oil and metal in the ground will stop looking like speculative plays and start looking more like stores of value.

A Pending Rocket Ride

…There is widespread belief that the U.S. economy is in a sweet spot, with a goldilocks-like ability to push profits up while keeping short-term interest rates near zero. The Fed is widely revered at moment for having succeeded in its mission. Some bulls are even musing aloud now whether the “great recession” was even all that “great” – as if it were over and done, finis, all consequences postponed indefinitely.

It is an environment, in other words, that very much favors “paper” (leveraged financial plays) over “stuff” (hard assets).

But when faith in Western governments’ ability to shoulder the sovereign debt load evaporates, that equation will reverse rapidly.

And so, after a period of renewed fiscal panic, in which it is driven home, yet again, that the grossly indebted central bankers of the world do NOT have control – only the illusion of it – a need to take shelter from the ensuing inflationary paper-debasement storm will become paramount.

THAT is when hard assets will become most attractive… not as hot money speculative vehicles, but emergency stores of value. A true rocket ride for commodity prices – the likes of which we haven’t seen yet – could be the result…

As the sovereign debt crisis unfolds, investors may well flock to these “hard” currencies in droves as their home-based scrip turns to confetti.

Business Insider: So, How Are Stock Prices Now That We’re Back At DOW 11,000? They’re 30% Overvalued

So, how do stock values look now that the DOW is back to 11,000?

Not outrageous. But certainly not cheap.

Measured using our favorite valuation technique, Professor Shiller’s cyclically adjusted PE analysis, the S&P 500 has a PE of 22X. The long-term average (1880-2010) is about 16X. The current level is actually close to the big bull market peaks of the past–with the exception of the gigantic one that peaked in 2000.

Note a few things:

* The long-term average for the cyclically adjusted PE is about 16X.
* Stocks have spent vast periods above the average and vast periods below it, usually in multi-decade cycles
* We’ve just descended from the longest period of extreme overvaluation in history, suggesting (to us, anyway) that the next multi-decade cycle is likely to be below average
* At today’s level, 1200 on the S&P, stocks are trading at a 22X CAPE, about 30% above the long-term average

Now…valuation doesn’t tell you anything about what will happen next…. (S)tocks can get a great deal MORE overvalued than they are today. And they can stay even more overvalued for a decade or more.

But what the apparent overvaluation does tell you–or, at least, has told you in the past–is that your future long-term returns will likely be below average. There’s a strong correlation between starting valuations and ending returns (high valuations lead to low returns and low valuations lead to high returns). And today’s valuations can now be described as “high.” (Not extreme, but high.)

Yes, you can argue that “it’s different this time.” You can argue that, since stocks have traded at an average CAPE of more than 20X for the past two decades, we’re in a new normal. And you might be right. But they don’t call “it’s different this time” the “four most expensive words in the English language” for nothing.

The Daily Reckoning: Stop Worrying About the Financial Crisis

by Bill Bonner

When will the de-leveraging bust resume?

When we stop worrying about it.

This afternoon, we realized that deep down, our feelings had changed: we had stopped worrying about a resumption of the bear market.

Not that we’ve stopped thinking about it. We think about it every day. And we’re sure it’s coming. But we have stopped worrying. No matter what we think, we feel that somehow this will work out okay…we’ll be all right. We’ll stumble along…

Thinking and worrying are two very different things.

Thinking is purely superficial. It’s the worrying that counts. When you’re worried about a financial crisis, you sell out your risky positions and hunker down with cash. When you’re not worried, you’re happy to float along… You’ll change course when the danger becomes more imminent, you tell yourself.

But don’t forget:

This is a Great Correction. It began almost exactly three years ago, when New Century Financial – the second largest subprime mortgage company in the US – filed for bankruptcy. It will continue until debt levels in the private sector have worked themselves down to more reasonable levels.

How long will that take? Maybe 5 years. Maybe 20.

Meanwhile, you can’t expect much from this economy. Businesses are not going to add jobs. Consumers are not going to shop.

Is that all there is to it? No, there’s a lot more. That’s why it’s a Great Correction and not just an ordinary run-of-the-mill correction.

…there’s the correction of the huge the expansion of credit

…there’s also the correction of the stock market

…and the correction of the real estate bubble

…and the correction of the world economy and its dollar-based monetary system

Here’s what to expect:

…US stocks will begin falling again

…foreclosures, already running at twice their normal level, will increase

…bankruptcies, now at record levels, will go up too

…bonds will eventually collapse (but may turn out to be decent investments for a while longer…as the de-leveraging continues)

…the dollar too could go up when the crisis feeling returns; over the longer run it will be dangerous to hold it

…China will go through a financial crisis (potentially ‘Dubai times 1,000.’ As Jim Chanos puts it)

…states, cities, and entire countries will declare bankruptcy…

Those things don’t seem like threats to you? Well, they don’t feel like threats to us either. But that’s what makes them so dangerous…

…we’ve stopped worrying about them.

InvestorsInsight.com: Is This a Recovery?

by John Mauldin

I think we are in for yet another Muddle Through period, at least for 5-7 years and maybe for the decade, depending on a few scenarios I will come to in a minute. …(I)f we measure the stock market by either earnings or dividend yields, valuations are in the top 10% historically. Average (!) returns, going out for ten years, are 2.6% real, with some historical 10-year periods being negative. Below is the range of returns, based on dividend yields. It does not look much different from the chart based on earnings. We are currently at the far right-hand bar.

This does not suggest a happy outcome for those who espouse buy-and-hope portfolios, at least not if you have expectations or needs of 7-8% or more.

Financial Armageddon: Time for the Bulls to Reconsider

Based on data going back 90 years, whenever the 12-month rate of change (ROC) in the Dow Jones Industrials Average has exceeded 40 percent, it has generally signaled trouble ahead.

In three cases, a 12-month ROC above that level has only marked a short-term pause, after which the market traded higher.

But on 11 other occasions, similarly rapid advances have been followed by notable corrections, including the collapses that followed the 1929 and dot-com era peaks, as well as the 1987 crash.

Given those odds, increasingly exuberant bulls might want to have a rethink.

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