Something We’ve Waited Months for Just Happened
Friday, January 18th, 2013
By Michael Lombardi, MBA for Profit Confidential
The world’s most widely followed stock market index, the Dow Jones Industrial Average, closed yesterday at 13,596.02. This is the index’s highest level since early October of 2012 when the Dow Jones Industrial Average hit a post-Great Recession high of 13,661.87.
At this point in the stock market, we have more bullishness than I’ve seen in years. I’m reading about many stock advisors saying the Dow Jones Industrial Average will move higher because the economy is doing “a lot” better.
Optimism reigns everywhere! We hear the real estate market is improving, we hear the unemployment rate is below eight percent for the first time since Obama took office. The “everything is okay now” comfort level has snuck right back in and the stock market is moving close to where it was in October of 2007. (It only took five years and trillions of dollars of newly created money to achieve it!)
I’m in that small—okay, let’s call it very small—camp that thinks otherwise. While the stock market could edge just a little higher here as the optimists pour more money into the market, my opinion is that the Dow Jones Industrial Average and, for that matter, most stock market indices are making one great big top.
Here are my five reasons why I believe the Dow Jones Industrial Average is making a top:
The number of stock advisors who have turned bullish is near a multi-month high, while the number of advisors turning bearish is at a multi-month low. This has proven to be a good contrarian indicator over the years, as it has been proven that when the great majority of stock advisors expect the stock market to go in one direction, the Dow Jones Industrial Average usually goes in the other direction.
Insider selling compared to insider buying is also near a multi-month low. This is negative for the Dow Jones Industrial Average.
Earnings growth for 2013 will be very limited compared to the past four years. Companies have cut their interest rate expense and have been able to borrow money at very cheap rates. This has helped corporate earnings immensely over the past four years. But where will earnings come from in 2013? Don’t look at consumers; they’re still not spending (mostly because they don’t have money to spend). The strong earnings coming out right now for the Dow Jones Industrial Average companies, when you look at them, are from the big banks—sure, they’ve been helped the most by the Fed.
World economies are slowing at their fastest pace since the Great Recession. American companies (40% of the S&P 500 companies derive sales from Europe) cannot help but see their earnings negatively affected as world economies slow.
Finally—and I know I have written about this many times in Profit Confidential—all we have experienced since the Great Recession is artificially low interest rates, trillions of dollars printed out of thin air, and trillions of dollars borrowed by the government. It’s all artificial! There has been no structural improvement to the economy. How do the Fed and government deleverage themselves now?
So there you have it. Yesterday was a very important day for the Dow Jones Industrial Average, as it has moved very close to what I believe will be a stock market top. Short sellers take note: a huge opportunity to make money as the market comes down is just upon us.
The year 2012 wasn’t a bad year for the stock market, thanks to the Federal Reserve keeping interest rates near zero and the Fed increasing the money supply to a record level. But for bonds, it was a breakeven year, as U.S. bonds closed out 2012 at about the same level they started the year.
The Federal Reserve has been keeping interest rates artificially low since the financial crisis struck the U.S. economy and investors in U.S. bonds faced falling yields and the price of bonds rose. (Bond prices go up when interest rates go down and vice-versa). Real returns on bonds are actually negative when one considers inflation.
Here’s a chart of the 30-year U.S. Treasury:
Chart courtesy of www.StockCharts.com
At the beginning of 2011, the yield on 30-year U.S. bonds went as high as 4.8 %. Now the same bonds yield is just a little above 3.0%. The 30-year U.S. bonds fell to as low as 2.4% in April of 2012.
Here’s the 10-year U.S. Treasury chart:
Chart courtesy of www.StockCharts.com
Same story; since the beginning of 2011, the yield on 10-year bonds has fallen more than 50%, to as low as 1.4% in April of 2012.
The big concern is that the longer the Federal Reserve keeps interest rates low, the more the chances of inflationary pressures. As inflation rises, investors in U.S. bonds get a lower real rate of return. In fact, investors in U.S. bonds might even be faced with negative returns after adjusting for inflation. Add to this the fact that the never-ending spending of our government could be destroying the credibility of U.S. bonds, and you have trouble.
Currently, the U.S. government has debt of more than $16.4 trillion (see the debt clock at www.investmentcontrarians.com) and, by no surprise, it continues to rise. Unfortunately, it doesn’t stop here; the Congressional Budget Office (CBO) estimates that, in the next 10 years, the national debt will increase to $20.0 trillion. (Source: Wall Street Journal, January 2, 2013.)
Credit rating agencies are already being cautious. Both Moody’s Investor Services and Standards & Poor’s (S&P) advised that the U.S. government has to take more measures to reduce its annual budget deficit (increase revenue or cut spending). The efforts to ward off the effects of the infamous “fiscal cliff” were not enough. Yesterday, Fitch Ratings said that if the U.S. doesn’t raise its debt ceiling by the end of February, its credit rating could be cut again. (Source: Toronto Star, January 15, 2013.)
If you own U.S. bonds, this seems to be a perfect time to pause and reflect.
The Federal Reserve has been keeping the interest rates low and inflationary pressures are building up fairly quickly—look at the food prices, oil, and other commodities. I believe the U.S. economy will weaken in 2013 and the Fed will have no choice but to keep the money taps open. This will push down the yield on U.S. bonds further, which is good for bonds.
But once interest rates start to move higher in the wake of rising inflation and too many dollars in circulation, interest rates could move up very quickly, causing a sudden fall in bond prices. As they say, “Investor Beware!”
What He Said:
“Despite all my ‘yelling’ and ‘screaming’ about gold, I believe only a few of my readers and a small fraction of the general public haven taken a position in gold. Why? Because gold’s not trendy…buying condominiums for investment is! If you are an investor, you need to seriously look at investing in gold stocks, because gold bullion prices will likely continue to rise.” Michael Lombardi in Profit Confidential, September, 21, 2005. Gold bullion was trading under $300.00 an ounce when Michael first started recommending gold-related investments.