11/3/2013 4:45 PM ET|
Why this rally may really be different
The old rules that suggest this market needs a correction may not apply when the Fed is pumping in liquidity and companies have tons of cash on hand.
The phrase "this time is different" marks the famous last words of many investors right before they lose their shirt.
But as the market continues to set new highs and comparisons to previous bull markets are unavoidable, it's worth asking the question if it's even fair to trot out some of these comparisons.
After all, a lot has changed in capital markets across the last few decades.
I know, I know. It is the height of bubble talk for a mouthy youngster to say history doesn't matter. And I'll admit that, at the end of the day, simple math regarding profits remains the prime driver of stocks across any era.
But comparing the stock market in 2013 to the stock market in 1970 is a bit like comparing Aaron Rogers to Bart Starr.
Sure, they are both Green Bay Packers quarterbacks… but the rules of football, the athleticism of players and the offensive strategies in the NFL have changed so much in four decades that the two almost played completely different games.
So how do you fairly compare these two Packer QB's? Even though they both share the same data set, they played in completely different eras.
This is the similar challenge facing investors right now. Because while we have a wealth of data across the last century or so, stocks are simply playing by different rules in an internet age than they did back in the days of Westinghouse and Woolworth.
Here's why I think that this time is different for stocks:
Valuations are different
By many measures, the stock market is at either its highest valuation ever or at least its highest pricing since right before the dot-com bubble burst.
The total value of mergers and acquisitions in Asia Pacific has dropped by 11% this year, but companies have plenty of cash on hand and are looking for opportunities to spend it, according to a survey by global law firm Hogan Lovells.
The Shiller P/E ratio, also known as CAPE, is at its highest levels since the dot-com era and higher than Black Monday in 1987. And the current market cap of the stock market is bigger than the gross national product of the U.S. for just the third time in history — the first two being in 2007 before the financial crisis and for a few years around 2000.
But investors need to ask themselves why we bother comparing stocks to the same valuation metrics from a century ago when so much has changed on Wall Street in regards to the way we trade and the way companies operate.
Prior to 1980, there wasn't widespread 401(k) investing or internet stock trading to bolster market liquidity. And corporate liquidity is equally supercharged — as evidenced by Apple (AAPL) , which just revealed it generated $10 billion in cash flow last quarter and is sitting on nearly $150 billion in cash and investments.
Yes, by a historical measure stock valuations are pretty high regardless of which calculation you prefer. But investors and corporations are simply not playing by the same rules as they did a century ago, so why should we use the same benchmarks?
The 'need' for a correction is different
In the broader context of stock market history, our current year-and-a-half run without a 10% or more correction seems pretty long.
But as Kopin Tan recently pointed out in Barron's, you only have to go back a decade to find a rally that was twice as long -- 1,153 trading days without a 10% rollback from March 2003 to October 2007.
And from 1990 to 1997, we enjoyed a massive 1,767 session run without a double-digit dip. That's almost five years!
There was indeed a lot of market volatility in the 1970s, but investors who look back 40 years or more for proof that we are “due” for a correction should remember how different the world has become in the intervening years.
It is indeed a bit baffling that the market's year-to-date returns since Jan. 1 have never dipped into the red. But investors who say stocks must decline simply because they haven't done so in a while are like the gamblers who put it all on red just because the roulette wheel has come up black five spins in a row.
Don't let the regular rollbacks of years past fool you into thinking that we have to have one this time.
The Fed's role is different
Perhaps the biggest reason that stocks continue to soar is that investors continue to drink out the quantitative easing punch bowl. And while some strongly believe that the Federal Reserve has an obligation to end the party before things get too sloppy, the sad reality is that the American economy is far from a party.
That means the Fed has an obligation to continue to play host and attempt to stimulate the economy — for as long as it takes.
We can moralize over how “good” it would be to have a strong dollar. But in 2013 a strong currency can actually work against your economy — as evidenced by central banks around the world, from China to Japan to the EU, debating how they can weaken their currencies to boost exports. Central banks worldwide are now fighting in a race to the bottom, and that's likely the new normal for the global economy for some time.
We can point to the hyperinflation of decades past and employ scare tactics to encourage tighter monetary policy, but the reality is that inflation is no big deal in 2013. As measured by the Consumer Price Index, inflation hasn't topped 3% since November 2011 and hasn't been above a 4% annual rate since the first few weeks of 2008.
And let's not forget that even if the central bank did decide to tighten things up sooner rather than later, there's nobody to pass the baton to. The private sector remains characterized by anemic hiring and the public sector is zero help thanks to cost cutting and partisan infighting in Washington.
Those who remember an age when interest-bearing assets yielded 10 times what they do now may yearn for a higher interest rate environment simply so they don't have to worry about stocks anymore. But times change and investors must change with them.
What if we never see a Fed funds rate above 4% ever again? It's not all that crazy to consider.
Just as the Fed is responding to the specifics of the current downturn and not following the script of years past, investors need to do the same.
And that may mean admitting that some historical norms for stocks simply aren't useful comparisons anymore.
Jeff Reeves is the editor of InvestorPlace.com. Follow him on Twitter @JeffReevesIP.
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Until the bills comes due.
1. " tons of cash" is sufficiently offset by tons of debt. These are not the droids you are looking for.
2. I think a Kool-Aid metaphor is more appropriate than your punchbowl reference to explain the misplaced faith in the Fed at this juncture. The idea that the Fed is somehow inflating stock prices with "liquidity" is absurd. ZIRP has encouraged yield chasing investors to bid up equity prices. This will end as badly as it always has.
This rally and Bull Market is no different than any other. If will rise far higher than most expect and it will FALL far lower than most expect. Meanwhile, the Big Boys are cashing out daily hoping more suckers can be drawn in before the Epic Correction begins.
Of COURSE, this time it's different, IT ALWAYS IS, and the result???
IT'S ALWAYS THE SAME...CRASH!!!!!
JUST ASK AROUND WHAT THAT WAS LIKE.
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