An amazing rally on Friday sent the market back up to those resistance levels. Far better than expected unemployment rate and jobs numbers sent the market higher, but didn’t bring forth too much taper talk. There were some concerns related to the numbers, beyond the headlines, but for the most part it was fairly good news. Could the market be prepared for the taper? That is a possibility and many thought that the market had priced in the taper that was expected to come in the 3rd quarter. We must also realize that any taper will be very small and mostly ceremonial. The question that is starting to make the rounds on the business media is, “Is the market overvalued?”
Overvalued is really in the eye of the beholder. I say that because the word “overvalued” can be tossed about too generally. Unless the “value” part of the equation is defined, what does “overvalued” really mean? Are we comparing earnings, sales/revenue growth, book value, stock price, or yield? As you can see there are numerous ways in which we can measure the “value” in which someone may consider it to be “overvalued”.
Courtesy of wikipedia
The recent Nobel Prize winning economist, Robert Shiller (of Case-Shiller Index), voiced his concerns about the market last week. He stated that US stocks are edging towards bubble territory. His argument is based on the Federal Reserve’s monetary policy of zero interest rates and QE money printing ($85 billion a month). Many, if not all economists, would agree that the Fed’s monetary policy has certainly helped elevate equity market prices; the debate is by how much. But there are more details to his concern. First, there are his concerns about the fundamental economics in the Western nations (U.S., Japan, and Europe), the still high unemployment rate, consumer debt, and stagnant domestic growth. Second, there is the concern that bond yields are artificially low (set by the Fed’s policy), making bonds and fixed income unattractive and forcing investors into equities for no other reason than that it is the only place to go. Lastly, there is a concern that market prices continue to outpace actual revenue/sales growth. I would add to his list of concerns, which I am sure he is aware of, the rather massive growing leverage debt in both the housing and equity markets. The NYSE measure of margin in equities has reached an all-time high this year, surpassing $400 billion. However, Shiller prefaced that by stating, “I’m not sounding the alarm yet…..the world is still very vulnerable to bubbles.” Ironically, Shiller won the Nobel Prize for his research and models in the forecasting of asset prices in the long term and helped in creation of index funds. It’s important to note his previous asset bubble predictions also proved to be correct.
It’s different this time.
What is fundamentally different this time, from both the Dot.com bubble and Housing bubble, is that the government is directly involved. In previous asset bubbles, the government was only indirectly involved by lowering interest rates and creating regulation to allow for excessive leverage. When the government lowers borrowing costs and lowers the collateral and eases lending restrictions, a bubble will form. This time the government has also directly participated in this asset inflation (bubble as some have called) because the Federal Reserve is actually printing money and purchasing assets. The Federal Reserve is buying both Mortgages (MBS) and Bonds, which has never been done before. They have created trillions in debt (leverage) that has helped pushed the market (equities, housing, and bonds) higher. It is this direct government intervention that makes it harder to measure the strength of the private sector, actual economic data, real asset values, and actual risk in the market place.
Shiller could very well be right, but much like Meredith Whitney and her prediction about Muni-bond failures, he could be very wrong for a long time before he is right. Just like Whitney I believe he is correct, but the problem with making predictions is always in the timing. We can never predict when it will happen, but the math shows that it is inevitable. The markets, just like the human beings that invest, are more concerned about the present and not the future. Humans live in the present, they forget the past (ignore it) and they don’t bother with the future. Society expects and measures impact today, immediate satisfaction, and reacts to fear and greed in the short-term. So when they hear warnings from the likes of Shiller and Whitney, they ignore them. Then when their predictions do not immediately happen, they quickly lose credibility. When Whitney’s prediction about the muni bond market didn’t materialize, she was chastized by the media and those in the bond market. However, Whitney has eventually proven to be correct, we have seen more and more bankruptcies in municipalities and more are expected to come. Whitney’s failure was in predicting WHEN it would happen, not just that it WILL. Shiller has been far more careful, perhaps his “I am not sounding the alarm yet…” will remove the target off his back.
2014 a better outlook!
A recent survey shows that economists generally have a better outlook for 2014. The economy has been adding 195,000 jobs on average per month and is improving. Unemployment rates are dropping and should be below 7% in the next quarter. The majority of those surveyed believe that the Fed will taper, but any taper will be very small so as to not disrupt the market. However, the one dark spot in the survey was consumer spending, which remained very tight. What is driving the better outlook is that the government continues to drive the economy with their monetary policy and they believe that any taper that would come will be small.
Courtesy of Shadowstats.com
Are we Overvalued?
So is this market overvalued? That depends on whether or not you accept the fact the government is participating in the market as the norm, then it is not overvalued. Because government intervention fixes interest rates, fixes bond prices, and drives leverage into the market that will supersede any private sector growth.
Do you not also find it ironic that the survey of economists have a better outlook for 2014 and expect that any taper will be small? What do you think their outlook for 2014 would be if they thought the government would END their QE policy all together or raise interest rates?
Support & Resistance
We rocketed back to 16,000 and many are wondering if we could push higher. I think the Fed could bring forth an x-mas gift if they stay the status quo and don’t mention anything about a Taper. However, if any hints of Fed stimulative contraction could bring back some market volatility.
The NDX is moving higher and it looks like some initial tech sales for the holiday are doing well. Microsoft sold out of their Surface 2 and I personally was looking at it and saw an amazing video that really showed how amazing this tablet is. Why I love my Surface 2 – I may have to get one.
The S&P index is holding up well and pushing above the 1800 level. The VIX is still in the mid 13 level and I am surprised it has broken lower in the high 12′s. That tells me the market is still pricing in some volatility at this point.
The one index that hasn’t fully bounced back yet is that RUT. It needs to push up above 1145. Keep watching the RUT and also the VIX.
Is Shiller right in his prediction and if so when will it happen? I personally agree with Shiller, but have a broader concern. I think there are some strong companies and sectors out there; I am still bullish on the global markets. My concern is that the inflated asset prices and bubbles are driven in most part by the Federal Reserve and central banks in the West and that means the asset bubble is not just equities, but also bonds and at its core the dollar.
If Shiller’s hypothesis is correct in that we are having an asset bubble in the market because of the Federal Reserve’s monetary policy, which includes printing trillions of dollars, logic would dictate that the bonds are also in a bubble, perhaps an even bigger one. It also means that the dollar is in a bubble as well.
When it will happen? I have no idea, right now I think we are living on faith, not credit. The fact that the rest of the West (Japan, U.K. and Europe) are playing the exact same game and that collectively they are the world’s top consumer nations, they could keep this game going for quite some time.
The endgame is when the producers (mainly the BRICs, Africa, OPEC, and emerging markets) are no longer willing to accept the West’s fiat paper as sound collateral. That is the bet that is going on right now and so far no nation has the balls to call the Fed’s bluff.
Remember, this happened once before in the 1960′s as the U.S. led the sales of the gold reserves into the London Gold pool to keep the dollar pegged to gold at $35 an ounce. It worked for almost 5 years, but required tons of gold to be sold and it came to an end when U.S. started running out of gold. Then they tried a two-tiered system, but that lasted less than two years. Eventually, the U.S.’s bluff was called and we were forced off the gold standard.
The point is you can’t stop the laws of supply and demand. While true, using debt/credit and faith, you can keep it going for a little while longer, but eventually it ends.
Courtesy of Shadowstats.com