Everybody loves a good joke, right? Jokes are funny, except when the joke is on you. Then, that particular joke isn’t very funny at all. This experience is particularly true when the bad joke leaves you stunned in shock and awe. Or poorer. With three rounds of Fed monetary stimulus on top of better than expected corporate earnings, which we will discuss here, It is not surprising to see the S&P 500 up 192% from that 3/9/09 bear market low. (Please note I did not say bottom.) Thanks to Bloomberg we can also observe the S&P 500 is trading at 18x earnings, which is around the highest valuation for the gauge since 2010. Here is the YouTube version in under 6 minutes, http://bit.ly/Markets-Love-Faking-Out-Investors
In the midst of the Middle East in realignment, Russia behind Malaysian Airlines 17, EU headwinds lead by Germany, residential real estate seems to recover and the DOW may soar to another all-time high . Look closer and you may find that 40% of earnings are from earnings increase from companies buying back stocks, which may lead to stocks divergence from earnings. Are these two markets just artificial bubbles over the past 5 years? Thanks to abnormally low interest rates, corporations have enjoyed reduced borrowing costs at all levels. Some observers like to point to job growth, but as we look at the income levels of these new jobs, they are not at the same quality as the jobs lost. The Fed has given investors nowhere to go but stocks. Commodities may be off from their top and gold and silver are lower than they were. It doesn’t matter whether or not you can understand a bubble or if you can explain it, one thing is for sure; all bubbles burst. That happens 100% of the time. There are no exceptions.
These times are neither normal nor the best of times
Nothing grows exponentially without becoming unattractive from high prices or wearing itself out. Harry Dent points out there are 4 primary cycles pointing down all at the same time. They are:
- The 10 year business cycle,
- The 45 year innovation cycle
- The 35 year geopolitical cycle (we went 18 years from 1983 to 2000 without much world drama, then the tech wreck and 9/11 happened, it’s been one thing after another ever since including Arab Spring, Syria, Iraq, North Korea)
- And the 30 year generation cycle pointing south since 2001.
The demographic spending cycle is the one you may find most revealing so keep reading. Countries today have the highest debt ratios than ever. Because of the risk, this is not a time for 17x or 18x price earnings. This time is not like 2000 or 1929. The 45 innovation cycle is the result of technology changes that change everything. Rail roads and steam ships and cars, for example. Basically every 45 years something is invented that goes mainstream and saturates the economy.
Today is a very dangerous time for the economies of the world. The Fed along with other central banks would have you believe it is possible to set the thermostat in the room and the machines will do all of the hard work. The best possible scenario is that the governments have figured out how to eliminate bad times. Disneyland might be the happiest place on earth, but life in the real world can hurt if you survive whatever went bump in the middle of the night. It’s always the bus you didn’t see, won’t name and you can’t time that can disrupt your day when crossing the street. If you are looking for a sign of what may lie ahead, pay close attention to the S&P 500 and the geopolitical drama. Look to see where that market closes over the short term. I f you see the S&P 500 closing north of 2000 that may be a bullish sign. If you see the largest stock market index closing below 1900 that may be the indication of a bear market. If the S&P 500 drops below 1800 that may be the beginning of an extended bear market.
It doesn’t matter until it does
As we study bubbles going back to the tulip bubble in Amsterdam back in the 1600s we see that everybody is in on the good news until the news turns really bad, then prices go back to where the bubble began. Something like a loss of between -70%-90%. The real estate and stock markets are ignoring this, but that may not continue much longer. Something has to give in Iraq and Ukraine. As theoretical physicist Michio Kaku, Ph.D.pointed out about geopolitical events when we met at a recent conference I attended in New Orleans, “Notice these events are happening in countries where there is little or no democracy and little or no internet.” He went on to say that every 80 years or so markets experience 70%-90% corrections. The first crash can be violent. Then there can be a rebound. You remember tech stocks fell 40% in the first quick crash in 2000, then bounced back faking investors out, then continued the downward spiral. The Nasdaq peaked at 5048 on 3/14/00 and bottomed at 114 on 10/8/02, which is a 78% loss, according to Yahoo Finance. Total investor leverage to buy stocks may be higher now than it was in 2007 and even higher than what we saw in the tech bubble. Margin debt appears to be at new highs. Investors in real estate and the stock markets are convinced that there is no downside risk. With no stimulus we would have had a depression, not a tepid recovery. With thanks to the Fed for low borrowing costs and because of company buy-back programs equity markets keep marching north.
Huge economic headwind 2014
But there is a huge headwind that is unfolding this year. Look at the Total Consumer Spending chart here. What you see is what some call a demographic cliff. We must pay attention to the average consumer. It is Homer Simpson driving the economic bus. The average American starts work at 20 and buys their largest home late 30’s to early 40s. That was 2000. Spending peaks at age 46. That was 2007. Spending continues until age 53 for the high income earners. That is 2014. The top 20% control over 50% of spending. The top 1% control 20% of all spending and hold 50% of the wealth. This could begin to explain the boom in auto sales this year. The Fed is doing all things possible to make you spend money. But life just happens anyway. Boomers today range from 50-68 years old. Outside of health care, what do Boomer need to spend money on? Not much. W. Michael Cox was the Chief Economist at the Federal Reserve Bank of Dallas. It was a pleasure to meet Mike because it appears that we are singing from the same hymnal. Cox observes:
“Buy and hold is no longer always good for capital gains. Investors may need to buy and sell to try and get ahead. Or let somebody do it for you. Unlike the past 25 years, the road ahead could be a bumpy ride.”
I couldn’t agree more.