As the key stock indices continue to climb higher, optimism amongst investors and stock advisors rises to a dangerous level.
According to the Advisor Sentiment tracked by Investors Intelligence, an indicator I follow to gauge optimism in the stock market, the number of stock advisors who are bullish towards key stock indices is at its highest since April of 2011. (Source: Investors Intelligence, May 22, 2013.) To bring this into perspective, in April of 2011, the key stock indices like the S&P 500 started to decline, dropping nearly 20% through October of that year.
The stock market is becoming very overbought and very overpriced. It’s not a matter of “if” the market faces a major set-back, but “when.”
The U.S. economy continues to struggle and early indicators of economic slowdown are flashing warning signs. Consider the Business Outlook Survey by the Federal Reserve Bank of Philadelphia, which provides an outlook for manufacturing activity in the Philadelphia area. The survey indicates demand has been weak, with new orders and shipments declining and inventories building up. (Source: Federal Reserve Bank of Philadelphia, May 16, 2013.)
The index of current manufacturing activity in the Philadelphia region registered at negative 5.3 in May compared to positive 1.3 in April. Any number below zero indicates conditions in the manufacturing sector are becoming poor.
This isn’t the only troubling statistic that shows the U.S. economy is headed towards an economic slowdown. Our economic growth is questionable; unemployment is still staggering; the majority of jobs created since the financial crisis have been in low-paying jobs, and a significant portion of the U.S. population is on food stamps.
Going back to the stock market…
Companies in the key stock indices aren’t really earning more; rather, it appears they are making more because of two financial maneuvers: cost-cutting and stock buybacks. As of May 17, 463 companies on the S&P 500 have already reported their corporate earnings. While a significant number were able to beat earnings estimates, only 47% were able to show revenues that met Wall Street’s expectations. (Source: FactSet, May 17, 2013.)
If the percentage of S&P 500 companies showing revenues below expectations remains at 47%, by the time they are done reporting their corporate earnings, the first quarter of 2013 will be the third in the last four quarters that the S&P 500 companies didn’t meet their revenue expectations.
What’s happening in the global economy isn’t supporting the key stock indices. Major economic hubs are facing pressures and experiencing an economic slowdown. China, Japan, England, and the eurozone—all these countries have slowing economies.
The rise in the key stock indices has become a joke—there is nothing behind the rise in stock prices except artificially low interest rates and plenty of paper money printing forcing investors into overpriced stocks.
Sure, it’s certainly difficult to be a bear these days as the key stock indices paint a pretty picture. But a great amount of caution should be taken as the risks continue to pile higher each time the stock market moves higher. Just some minor profit-taking can turn into a broad market sell-off.
While testifying in front of the Joint Economic Committee in Washington regarding monetary policy and the economic outlook of the U.S. economy, the Chairman of the Federal Reserve, Ben Bernanke, said yesterday, “…the committee has said that it will continue its securities purchase until the outlook for the labor market has improved substantially in a context of price stability.” (Source: “The Economic Outlook,” Board of Governors of the Federal Reserve System, May 22, 2013.) In other words, the Federal Reserve has made it clear, once again: it will not stop quantitative easing until the unemployment rate comes down.
The Federal Reserve continues printing $85.0 billion a month in new money, using this newly created money to purchase long-term U.S. bonds and mortgage-backed securities (MBS). The Fed has already inflated its balance sheet to over $3.0 trillion, and by keeping the pace of quantitative easing the same, its balance sheet will reach $4.0 trillion very quickly.
I believe the longer the Federal Reserve continues with the quantitative easing, the bigger the eventual troubles will be.
First of all, quantitative easing and artificially low interest rates by the Federal Reserve have essentially forced investors to take higher risk elsewhere, as guaranteed yields have collapsed. The yield on 10-year U.S. bonds is less than two percent; meanwhile, tax-favored dividends from the rising Dow Jones Industrial Average stocks pay 2.35%.
It is very well documented in these pages how investors are rushing to get higher yields as the Federal Reserve stays the course. Investors are adding junk bonds to their portfolio; conservative investors, like the central banks, are buying stocks; and bond funds are buying stocks, too. In the housing market, we have institutions buying distressed properties for cash, so they can fix them up and rent them out in hopes of a higher rate of return.
Secondly, the more paper money the Federal Reserve prints and injects into the U.S. economy, the bigger the impact it will have on the buying power of the average American. Inflation, which the Consumer Price Index (CPI) says is not there, is rising.
Last but not least, quantitative easing promised economic growth, but we really haven’t gotten it yet. We still have a significant number of Americans unemployed or working part-time because they are unable to find full-time jobs. But, oh yes, the stock market has risen.
Prolonged quantitative easing has not helped the U.S. economy; rather, it is creating bigger issues that we will eventually need to deal with, like the current stock market bubble. We only need to look at the Japanese economy to see the ineffectiveness of continued quantitative easing—it doesn’t work in the long term. Throwing money at our problems doesn’t solve the problems.
What He Said:
“Anyway you look at it; the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in Profit Confidential, August 27, 2007. This was a dire prediction that came true.