The fundamental backdrop behind the ramp higher in equity prices in 2013 is
far from inspiring. However, fundamentals do not matter when the Federal Reserve
is flooding U.S. financial markets with an ocean of freshly printed fiat dollars.
As we approach the holiday season, retail stores are usually in a position
of strength. However, this year holiday sales are expected to be lower than
the previous year based on analysts commentary and surveys that have been completed.
This holiday season analysts are not expecting strong sales growth. However,
in light of all of this U.S. stocks continue to move higher.
Earnings growth, sales growth, or strong management are irrelevant in determining
price action in today's stock market. In fact, the entire business cycle has
been replaced with the quantitative easing and a Federal Reserve that is inflating
two massive bubbles simultaneously.
Through artificially low interest rates largely resulting from bond buying,
the Federal Reserve has created a bubble in Treasury bonds. In addition to
the Treasury bubble, we are seeing wild price action in equity markets as hot
money flows seek a higher return. Usually fundamentals such as earnings, earnings
estimates, and profitability drive stock prices. However, as can be seen below
the U.S. stock market is being driven by something totally different.
The chart above is beginning to illustrate that fundamentals are becoming
irrelevant. The only thing that matters in today's marketplace is the flow
of fresh liquidity out of the Federal Reserve and into the banking system.
This process helps to fuel more risk taking and pushes longer-term investors
away as hot, speculative money flows into high risk assets.
The chart below, which came from Thomson I/B/E/S demonstrates that the future
outlook is clearly not any better.
As can be seen above, over 90% of the S&P 500 companies have already reported
negative 4th quarter 2013 pre-announcements. Essentially, these companies are
warning equity investors that earnings expectations are going to be lower than
expected.
Normally this would be seen as a headwind for equity prices particularly because
the ratio is the worst on record. However, equity prices have rallied straight
through the dismal earnings data.
In addition to earnings, global leading indicator analysis from Goldman Sachs
is also issuing warning signals. The Global Leading Indicator Swirlogram is
showing decisively that global leading indicators are slowing down and are
moving toward possible contraction presently.
On top of consistently lowered earnings estimates and forward guidance in
S&P 500 companies at the worst levels on record, we are seeing evidence
that would suggest the global economy is slowing down. In light of this information,
how can risk assets be rallying?
The weekly chart of the S&P 500 Cash Index (SPX) going back to the beginning
of 2012 tells a rather compelling story. The S&P 500 Index in that period
of time has rallied by more than 43% as shown below.
However, readers should note that the past 6 - 8 weeks have seen prices move
higher. In fact, the last time the S&P 500 Index had 7 consecutive weeks
of higher prices was back in 2007. In light of the negative fundamental data,
this is the price action we are witnessing in real time.
How can anyone realistically purchase risk assets here? I realize that prices
could go higher and likely will go higher if the Federal Reserve continues
to accommodate the U.S. capital markets.
However, as prices move higher and bears continually get run over at some
point a correction or possibly worse could be initiated. Clearly a bubble has
formed in Treasuries, but if this type of price action continues a bubble will
form in equities as well. Several famous financial pundits are already beginning
to discuss this very real possibility.
Financial pundits and asset managers are beginning to come forward to discuss
their views that equities are at full value and are forming a possible asset
bubble. Famous investors and portfolio managers like Larry Fink and Carl Icahn
have stated recently that they believe the U.S. equity market is moving into
dangerous territory where large corrections could loom in the future.
Furthermore, in a recent interview with Fox News, renowned economist and political
pundit David Stockman made the following statements:
"This is the fourth bubble the Fed has created through easy money and
printing press expansion."
"The Fed has taken itself hostage."
"This is a destructive poisonous monetary medicine that is being put
into the system that is distorting all kinds of economic mechanisms with
mal-investments on a massive scale."
Stockman concludes that "its like 2007 - 2008 all over again." Whether
the bubble exists in the Treasury market or in U.S. equities is hard to say.
In fact, we maybe witnessing bubbles in both asset classes and history says
the endgame will likely end badly.
I want to be clear that many times bubbles are viewed in hindsight and we
may be months or even years from the top. What I do know is that the Federal
Reserve has a horrible track record. They have reduced the U.S. Dollar's purchasing
power incredibly since their inception. Additionally they have always reduced
economic stimulus too late and inflation has ravaged markets historically.
While I do not know when the bubbles will burst, what is known is that recently
the mere mention of a possible tapering of the Fed's Quantitative Easing program
sent U.S. stocks considerably lower.
All eyes are on the Fed and when they finally taper, they will find out that
they are trapped. While prices may continue higher for months or years in the
future, history suggests the endgame will be ugly for those who chased the
speculative bubbles.
In closing, I will leave you with a quote from a recent interview with legendary
investor Jim Rogers, "The Fed will self-destruct, before the politicians realize
what is going on."
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