1/30/2013 6:15 PM ET|
Bull market or prelude to a bust?
The markets are nearing levels not seen since 2007 -- but let's not forget the crash that followed those highs. Conditions now look eerily similar.
There's a new exuberance sweeping the market. Major U.S. stock indexes are approaching new highs for the first time since 2007. The Dow Jones Industrial Average ($INDU) is flirting with 14,000 again.
The surge started after Washington compromised on the fiscal cliff, releasing a pent-up surge of buying demand as investors enjoyed a reprieve from budget worries, the eurozone crisis and other concerns. Also contributing: Japan's aggressive efforts to weaken the yen, which have added another central bank to the list of those abusing their currencies to pump cash into the system. Even retail investors are stepping back into stocks.
So why do I remain skeptical? Why not just throw in, set worries aside and enjoy the ride?
Because to me, this looks like 2007 all over again, with a burst of exuberance just before it all comes crashing down. Here's why I'm a doubter, and how to play it if you share those doubts. And if you don't? I'll suggest some areas worth considering if you're feeling cautiously bullish.
Party before the storm
Even as stocks crawl to new highs, there is growing evidence that this bull market -- now in its fifth calendar year -- has entered its terminal phase.
Late-stage bull markets are typified by explosions of sentiment, like the current rally. They're also marked by an erosion of economic fundamentals and a general postponement of disbelief, like we're seeing now.
In fact, the similarities between the current run and the 2007 bull market top are striking.
The gains in the major averages haven't been confirmed by rising trading volume, broad participation across the stock universe or gains in ancillary markets like commodities or emerging markets.
In fact, we're seeing investors moving out of economically sensitive sectors like basic materials and steel-makers and into less-sensitive defensive stocks like Procter & Gamble (PG) and health care issues. The move comes against a steady rollout of declining economic data, including terrible consumer confidence readings. We're also seeing ongoing confirmation that the fourth-quarter earnings season is likely to be a disappointment, tracking below expectations so far.
Yet all the negative catalysts are being ignored by the bulls, which is what we saw in 2007 and is typical of last-gasp rallies. There are also constant reminders that bullish exuberance is reaching historic levels.
People are ignoring the very real fiscal policy risks the U.S. faces over the next few weeks; yes, the debt-ceiling debate was postponed until May, but the "sequester" budget cuts and the need for a new federal spending plan hit much sooner.
We're also seeing rising resistance of inflation hawks at the Federal Reserve, the European Central Bank and elsewhere to the rich world's experiment with extreme monetary policy easing (which is growing increasingly ineffectual).
People believe Europe has been fixed. (It hasn't, and Germany is falling into recession.)
People believe 2% inflation will end Japan's multidecade malaise. (It won't.)
People believe tapped-out U.S. consumers and the nervous corporate sector will spend and invest despite the uncertainty, stagnant wages and new taxes. (They won't.)
People believe both earnings growth and growth of the gross domestic product will reaccelerate later this year, yet I see clear signs of lost momentum in both earning power and economic vigor.
Shades of 2007
Just look at the chart below of the 2007 market high.
Stocks peaked on Oct. 9 that year, at a time when conditions looked remarkably similar to how they look today. Stocks had suffered a double-dip in the previous year and had pushed over old highs set a few months prior. All was right with the world, and the market was going vertical. Bullish sentiment surged, and skeptics were dismissed.
Then, like now, hopes were high that an unquantifiable risk (the subprime problem) would be contained and papered over by the Federal Reserve. Then, like now, corporate earnings were under pressure from weak revenue growth and rising costs, but there was hope Chinese demand would compensate.
Then, like now, the market had separated massively from the economic fundamentals -- as shown in the chart below of the Citigroup U.S. Economic Surprise Index (which measures where the real data is coming in, compared with Wall Street expectations) versus the Standard & Poor's 500 Index ($INX).
People were lulled into a false sense of security by ridiculous, outlier data points that were later downwardly revised. Then, it was GDP growth estimates. In 2007, the bull market top was fueled by second- and third-quarter GDP growth estimates of 3.8% and 3.9%. This reversed a two-year deceleration in growth and confounded the pessimists.
Now, it's a drop in the unemployment rate driven not by job growth but by people leaving the workforce in disgust -- which is why the employment-to-population rate has fallen to early-1980s levels.
Within a year of 2007’s rosy predictions,the economy was miredin recession. The chart below shows what happened to stocks.
After the dust settled, the government revised those 2007 growth estimates down to 2.5% and 2.2%. But of course, it didn't refund the losses suffered by investors who, in October 2007, wanted to believe Uncle Sam.
What makes me think something similar could happen now?
Most important, the stock market has disconnected from economic realities on the ground again, as shown below.
I'll add two more things:
- The CBOE Market Volatility Index ($VIX), a commonly used gauge of market unease, is finally showing signs of caution. A more obscure gauge of this in the options market, the Credit Suisse Fear Barometer, has been showing the same for weeks. Maybe the fog of irrationality and lingering good vibes from the fiscal cliff deal are ending. Whatever the cause, options traders are starting to worry about downside risk again -- and are paying up for protection from downside losses.
- Despite impressions to the contrary, fourth-quarter earnings season is turning into a dud. As of Jan. 25, with 47% of the S&P 500 reporting, earnings are tracking 6% below the $25.51 consensus estimate on Jan. 4. Of those companies that have reported, they've collectively missed the consensus estimate for their share of total S&P 500 earnings by 13%. Because of this, the 53% of companies left to report had better be bringing good numbers, or we could be looking at an outright drop in earnings per share versus last year.
So while we face the prospect of negative EPS growth this quarter, bottom-up Wall Street analysts (a traditionally bullish bunch) are looking for earnings growth to reaccelerate to a mind-numbing 23% rate by the fourth quarter of 2013.
That just won't happen. Nor is GDP growth going to reaccelerate to more than 3% later this year, as many economists believe.
Weak earnings. Weak economy. Fiscal austerity and political uncertainty. Higher taxes. Narrowing market participation. Weakness in industrial metals.
And yet, extreme bullish sentiment and one of the least volatile rallies in the past 40 years.
By all indications, the current surge is a blow-off top, just like the one we had in 2007.
VIDEO ON MSN MONEY
My Scots-Irish Grandfather said: The best way to double your money is to fold it once and put it your pocket. Of course he also said it is a shame to waste a healthy liver on sobriety. He's not far wrong on either count!
Anyone can correctly predict a downturn in the market, you just keep predicting it until you're right. It's kind of the whole "timing" thing that's the challenging part.
Wall Street and CNBC reporters can't be trusted. They are all full of it!! Plus both Wall Street and the media stock reporters are trying to sink the Obama administration because he is going after the thieves on Wall Street. Coming soon!!!
Now, I have come to grips with the fact that the market will never again really represent the economy as it pertains to jobs. Jobs in the USA are gone forever, we were sold out by Wall Street / big corporations, and it looks like we need to get use to the fact that we are never going to have much better unemployment numbers than we see today. But, big corporations / business can and will still make record profits thus creating a strong stock market at least for short terms. We see this today in that many companies are doing well and are good investments but, again it will be short term and we need to get use to this because this also will not change back to as we knew market runs in the past.
Strange isn't it...
Precious metals are up...
Stocks are up...
the US dollar is being devalued by the minute...
the Fed printing presses are running 24/7/365...
Our national debt clock is racking up debt faster than ever...
All H_ll is about to break out in the Middle East...
North Korea is about to test LR nuclear weapons...
And Obama says all is well in the Rose garden!
Bend over and kiss your as_ goodby as the big meltdown is imminent!
Whoda thunk that?
All my local bank did with their FREE tax payers money was, build 6 new branches and change their slogan from. "Your Friendly Local Bank" to "Your Friendly Regional Bank."
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