Today we have a plethora of companies reporting earnings and are moving through
the 1st Quarter earnings season at a rapid pace. Thus far, earnings have been
far from exciting and have made the previous 2013 forward earnings estimates
laughable.
The only way we get to the proposed valuations is through multiple expansion
which is simply going to require the Federal Reserve to continue to pump $85
billion into Treasury's and MBS securities each month. I am confident they
will comply.
There are a few analysts out there who are discussing the potential bubble
forming in equities and other risk assets as Bernanke's plan is working to
the extent that asset prices are rising. However, even fewer analysts are pointing
out that both retail and institutional money is constantly chasing yield at
this point.
Simply take a look at the 2013 price action in high yield dividend paying
stocks, high yield bonds, preferred stocks, and master limited partnerships.
It is safe to say that a bubble has formed not just in equities, but in various
fixed investments as well. Consider the following chart of the S&P 500
Index (SPX) shown as the dotted trendline and Johnson & Johnson (JNJ) shown
as the solid black line.
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Obviously from looking at the chart above, JNJ has outperformed the S&P
500 Index year to date. Has JNJ suddenly become a growth giant? Is it all about
earnings growth and/or forward earnings potential or anticipated growth?
Or is the rally in JNJ really about the fact that Johnson & Johnson has
a long history of paying strong, rising dividends. I am sure there are plenty
of sell side analysts who will tell you that JNJ is going to $100 / share in
the future for a variety of macro or quantitative reasons.
The sell-side analysts will tell you the economy is strengthening or that
large cap multinational companies are seeing strengthening fundamentals and
earnings growth. They are called the sell-side for a reason; they want to sell
you stock.
Furthermore, my favorite recent discussion is about future earnings projections
and the new strength that we are going to see in earnings. The following chart
was posted at www.zerohedge.com and
originally came from Standard & Poors. The chart below illustrates the
trailing 12 month operating earnings per share of S&P 500 companies.
Based on the above data, how is the stock market fundamentally sound when
earnings are collapsing? I guess the Federal Reserve is going to print profits
for the S&P 500 companies. Actually earnings are irrelevant when central
banks all over the world including the Federal Reserve are juicing the markets
with a sea of liquidity and where multiple expansion trumps real earnings or
value.
Furthermore, these same central banks are openly purchasing equities and allocating
sizable portions of their balance sheets to stocks. Several central banks around
the world have more than 10% of their reserves allocated to stocks at this
point in time. The world is long risk and money is still flowing into bonds
at the same time. Simply look at the recent price action in Treasury's for
the past few weeks or note the strength in municipal bonds in aggregate since
mid-March.
This brings me to my final point. For the past several years, bonds and stocks
in the United States have rallied together. U.S. treasuries and domestic equities
have been trending higher for more than three years as shown below. The S&P
500 is shown as the dotted line and the 30 Year Treasury Bond Price Index is
the black solid line.
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It is without question that both the S&P 500 Index and the 30 Year Treasury
Bond have been trending higher for the past 3 years overall. Both underlying
assets have produced strong gains during the same period of time. Now this
brings me to my final question for readers to ponder. If both the S&P 500
Index and the 30 Year Treasury Bond can rally together, what happens if they
selloff together?
The answer to that question is the real problem. Many sell-side analysts and
economists ignore the bubble that the Federal Reserve has created in equity
valuations. The bubble continues to be fueled by the monstrous liquidity injections
that they have conducted beginning with the original quantitative easing. However,
what is even less acknowledged by the sell-side is the massive artificial bullish
valuations that have been created in the bond market.
Long dated treasuries are being purchased by the Federal Reserve to artificially
hold down interest rates. This ongoing practice is causing a separate bubble
to form in fixed income investments. So now we have a bubble in equities and
long-dated treasuries forming and the sell-side continues to trumpet that higher
prices are likely. Ultimately the sell-side may be right in short to intermediate
time frame, but the end game has a finality that few want to consider.
When these bubbles finally pop as all excessively valued assets do, the result
is going to devastate financial markets. It may be in 6 months or it may be
in 10 years, but history will not be thwarted. The central banks can try to
outsmart history, but they will ultimately fail.
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