Gary ShillingŐs Insight...
I borrowed the title from GaryŐs latest newsletter. He has 31 pages of details and graphs and makes a compelling case as to why this market is on its last hurrah. He points out the gap between the anemic growth of most economies around the world and the vast sea of liquidity being pumped out by central banks across the world. ŇDonŐt fight the FedÓ is the rallying cry.
The markets have responded and are within striking distance of 2007 highs. The equity markets rallied in the latter half of 2012 and even depression-plagued Greece rallied Đ up 33% last year as everyone assumes the crisis will continue to be solved by throwing more money out the door to keep the entire Eurozone alive.
Record-low interest rates have failed to stimulate lending as banks shy away from all but the best of credit records. The Fed has embarked upon massive purchases of government securities. This has failed to spur housing or job growth, both keys to real growth.
The concept would be that the massive liquidity would push money into stocks, lifting the wealth effect and stimulating spending which in turn creates more need for additional labor force.
So far, the proceeds seem to be piling up on the reserves of the banks. In the past when the Fed adds a dollar to reserves, it has created $70 in M2 money. But since August 2008, the multiplier has been a miserly 1.8. Excess reserves have exceeded $1.5 trillion so the effect the Fed anticipated has not taken place and may not.
Junk spreads tighten...
As the Fed lowered rates, investors desperate for yield purchased junk bonds and emerging market bonds with little regard for risk. Spreads of junk over Treasury yields have continued to narrow and currently are 2.7% over the yield on a Treasury. Junk had a great year last year and money continues to flow in. Issuers accommodated the demand and both foreign and domestic corporations issued new debt totaling a record $350 billion in 2012 up from the $286 billion prior record in 2010.
Europe joined this party as well issuing $16 Billion in January 2013 alone. Almost half of that total came from the most troubled countries: Spain, Greece, Italy, Portugal and Ireland Đ the PIIGS. Leveraged loans have also been hot as have leveraged-loan mutual funds and ETFŐs. They are both seeing record inflows of money.
The correlation of junk bonds and stocks is 0.65 . In 2008, stocks dropped 30% while junk fell 27%. The correlation between stocks and low quality emerging market debt is 0.60. At this point, investors do not seem to be cognizant that they are not being paid for the risk. At 6% for junk, a significant equity correction would wipe out many years of yield and that is not taking default into account.
This time is different...
That is what Barry Ritholtz said to me when we appeared on Bloomberg TV last month. I was noting that Ned DavisŐ sentiment numbers were off the charts. TraderŐs sentiment, as well as InvestorŐs Intelligence Advisors Sentiment is very optimistic. Individual investors have thrown in the towel on missing the equity market run-up and have been flocking in to stocks.
In January and February $20 billion flowed into stock funds, more than the entire 2012 fund flow. From the beginning of 2009 through 2012, individual investors yanked $287 billion out of U.S. equity funds. They have reversed this trend. BarryŐs point is that the individual investor had such a long streak pulling money out that this time is different and Ned DavisŐ sentiment numbers should be taken with a grain of salt as there is more room for investors to continue to rotate money out of bonds and into stocks.
I heard that beforeÉboth in 1999/2000 and in 2006/2007. I remember being on a CNBC show with a money manager in late 1999 and he was buying Google, Harley Davidson, Qualcomm, GE and other techie names as there was a Ňnew paradigm shiftÓ and all kinds of reasons these stocks would continue up.
We are hearing more of the same now. The average PE is 17 and corporations are doing stock buybacks while insiders continue to sell. According to Trim Tabs, the estimated float of shares of stock decreased by $100.9 billion in February, the biggest decline since July 2007. But insider buying was $100 million in February, the lowest on record. Do the insiders know something we should know?
Trim Tabs Liquidity points up...
According to Trim Tabs, liquidity flows have been extreme this year. Their liquidity indicators suggest stock prices can move higher. Inflows into U.S. ETFŐs have been light but foreign buying has been strong. This suggests U.S. indices will outperform foreign.
They argue that slow-growth economy and the FedŐs easy money policy will fuel equity prices and continue to foster corporate buying. They may indeed be correct and certainly you cannot fight the tape. However, from a technical perspective, it looks like the equity indices, especially the S&P are building a large top in here. The volatility has increased and VIX generally has a negative correlation with stocks. In the last week, we had four days with 100 point swings intra-day.
Summing it up...
In my opinion, the yellow caution light is on. Everyone seems to be anticipating a 5-10% pullback. Many investors (both professionals and individuals) missed the run-up especially the 7% year to date rally despite a fiscal cliff which is unresolved and now sequestration and continued fighting in D.C.
We have hit the year-end target for many of the Wall Street research houses. Some people feel that the 20% pullbacks we have had virtually each of the last few years have become the norm. Housing has not recovered. Most of the buying is in apartments and investments from foreclosures, short sales and general distressed bargains. China is putting the brakes on their housing bubble. Consumers are slowing down on consumption across the board as can be seen by the dismal reports from Walmart and JCPenney. Most countries rely on exports and if there is no demand then who is there to export to?
Baby boomers are not prepared for retirement so if there is another deep pullback, they may panic as they run out of time to Ňbuy and holdÓ and make it back. The echo-boomers are not gaining employment and many are living back at home. So the sale of the home that was supposed to fund retirement for the baby boomer is not taking place until junior gets his/her feet on the ground.
Take stock of what you own and look at downside risk. Housing stocks have doubled and more over the past 15 months. Nothing goes up forever. At $700 Apple was touted to hit $1000 next. At $430, it has dropped 38% from its high. If Apple was in the Dow, we would have a very different number for the index. Bulls make money, bears make money and pigs get slaughtered is the old adage. So do not be afraid to take some profits off the table. You can always buy a stock or fund back after a correction. We may continue to float higher in the near term but this is a high risk market from many perspectives so enter with caution.
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