Perspective on a Never Ending Bull Market

by The Curmudgeon

The latest Barron's cover says it all:  BULL TREAT.  This is the third Big Bull on a Barron's cover in the last six months!


The CURMUDGEON previously commented on Barron's April 22, 2013 Gloating Bull on a Pogo Stick cover in a post titled: Euphoric Bullish Sentiment on Wall Street Contrasts With Economic Pessimism on Main Street! 

In case you missed it, here's the gloating bull on Barron's Sept 2, 2013 cover- Fall Forecast: Sunny.



We're not surprised to see yet another bull on Barron's cover this week.  Maybe there will be one next month too?  The market has been incredibly resilient, with a unique ability to discount and celebrate the same event multiple times.  For example, the market rallied before AND after the end of U.S. government shutdown and threats of a debt ceiling default.  The event was discounted before being resolved and celebrated for several days afterwards.  That's not the way markets are supposed to work!


What the Market Analysts and Big Money Poll Managers are Saying:

In this Saturday's Barron's cover story, Robert Turner, Chairman of Turner Investments in Berwyn, Pa., calls this "the most joyless" bull market in history, given the doubts attendant to every point rise in the Dow. But you won't find much hand-wringing in his office, as he expects strength in corporate fundamentals to persist.  Why not?  We only have the weakest economic recovery since WWII accompanied by slowing profit growth and potentially rising long term interest rates.

Barron's Big Money poll managers view the stock market as the best place for your money over the next 12 months—and the next five years too! On a near-term basis, 80% expect equities to outperform all other asset classes, while 6% favor cash, and 6% like real estate.  About half of the managers think the U.S. will be the best-performing market in the next 12 months; 24% say European equities will shine brightest as the Continent emerges from a multiyear slump; and 8% are putting their money on Japan. Many managers expect emerging markets to do best over five years, outperforming the U.S., a reflection of the rapid growth of developing economies.

Norman Conley, CEO of JAG Capital Management in St. Louis, sees revenue growth as a key to lifting sectors. "There is only so much you can achieve from balance-sheet machinations, and the markets are slowly starting to recognize that," he says.  And this is one of the numerous fundamental problems The CURMUDGEON has been harping on for months, calling attention   that almost all of the after tax profit growth has come from cost cutting, overseas sales where the US $'s are not repatriated (and hence not taxed, e.g. Apple), and accounting shenanigans/gimmicks!  There's been very little increase in top line growth=total revenues.

Bears are an Endangered Species:

Just 8% of Big Money poll respondents describe themselves as bearish about the outlook for stocks through next June. Nearly one in four is neutral, up from 19% in the spring. The bears expect the Dow to close the year at about 14,450, and drop to 14,016 by next June. They see the S&P 500 falling to 1609 by year end and 1561 by mid-2014, and the Nasdaq trading at about 3400 in nine months, 13% below its current level.

Most bears say the bull market's fate is tied to future Fed moves to curb quantitative easing, as its bond-buying program is known. The Fed has been purchasing bonds to drive down interest rates and stimulate economic growth.

Jason Brady, manager of the Thornburg Strategic Income fund, says that accommodative Fed policy has pushed money into risky assets, artificially inflating stock prices. If corporate earnings falter and the Fed starts to taper, the rationale for current prices will be undermined


What About Valuations?

Are stock market valuations and earnings growth now irrelevant to this aging bull market? The S&P 500 is currently selling at 19.89 times earnings, near the high end of its historical range.  

The more revealing Shiller PE Ratio is currently at 24.95- higher than at any time between 1929 and 1996, but well below its 1999 dotcom peak of 44.2. 


Shiller PE Ratio Chart


In the last few years the market's rise has been primarily due to expansion of P/E ratios.  How long can that go on?  Citi equity analyst Tobias M Levkovich wrote in an Oct 19th note to clients: "Multiple P/E expansion has occurred already so some fear that it cannot get much better. With valuation having expanded, given that the S&P 500 has appreciated by roughly 20% relative to a 5%-6% earnings gain this year, there is anxiety that further enhancement is improbable especially with the potential for higher bond yields in the next couple of years.  Yet, such a perspective also assumes a resumption of inflation that is not showing up in any of the observed metrics."

A New Tech Bubble Takes Shape

Meanwhile, some market sectors are getting very pricey.   Many pros believe the surge in Internet and social media stocks is taking on the appearance of the dotcom bubble in 1999.   The biggest global Internet company-Google (GOOG) closed at $1011.41 on Friday - up +122.61 or 13.80% on the day!  Facebook has rallied sharply and Twitter's IPO -with an expected valuation north of $12B- is expected to raise investors’ animal spirits.  Doesn't matter that Twitter lost $65 million in the last quarter -its biggest quarterly shortfall since at least the start of 2011.

In this Sunday's NY Times, Nobel Prize winner Robert Shiller was asked by columnist Jeff Sommer if there are (financial market) bubbles.  He replied: "Yes, they happen all the time. Most of the action in the aggregate stock market is bubbles. That wouldn’t be as true for individual stocks, but it’s true for the overall market."

For more on the new tech bubble, here's a video on The Nasdaq ‘Echo-Bubble’ of 2013.


A Market Immune to Bad News:

Barron’s Ben Levisohn in The Houdini Market Wriggles Free of Bad News Yet Again. “There has been the flash crash, the Greek default drama, the U.S. debt-ceiling debacle, the Standard & Poor’s credit-rating downgrade of the U.S., the sequester, the great taper scare, and more. Each we were told could have ushered in a new bear market. Instead, the S&P 500 squirmed out of the traps and headed higher. And for its latest trick, the market had to avoid the double whammy of a government shutdown and a potential default.”

“Some investors doubted the market’s ability to wriggle free. They pulled $5.2 billion out of U.S. equity funds in the week ending on Oct. 9, according to the Investment Company Institute; the amount was more than the withdrawal in any single month this year.   Last Wednesday, however, Republicans and Democrats agreed on a deal to reopen the government and raise the debt ceiling, and the stock market surged higher. By the end of the showdown, the S&P 500 had gained 2.4% and finished last week at a new all-time high of 1,744.5, despite high-profile earnings misses from companies such as Goldman Sachs, IBM, and United Healthcare.”

The weight of the evidence clearly indicates that the market is no longer driven by earnings growth, valuations, or other fundamental metrics and is not intimidated by lower economic growth (like this year) due to a dysfunctional federal government

U.S. Dollar could be a Wild Card:


Very few financial journalists have called attention to the US dollar as having an impact on the stock market or world economy.  The US $ index closed Friday below its long term support of 80.  What if it breaks down from there?


If foreign central banks and international investors sell dollars, the U.S. Treasury would have to pay higher interest rates to attract foreign buyers of T-notes and T-bonds.  That would have a huge negative impact on the mortgage and real estate markets.  Higher debt service costs would increase the budget deficit and national debt.  The U.S. would also lose the insurance value of a currency that automatically strengthens when something goes wrong (whether at home or abroad). 


John Auther's wrote in this weekend's Financial Times (subscription required): "Immediately after the (debt default) resolution, Treasury yields fell while the U.S. dollar dropped sharply.   That is partly because the dollar acts as a haven, even when the U.S. is itself the centre of the risks arousing concern. It also reflects the growing unpopularity of the dollar. Foreigners would prefer to hold less of it."


"This can be seen in both words and deeds. Flows from foreign investors into U.S. stocks have been declining for months. Meanwhile, China has reduced the pace of its U.S. $ reserve accumulation since the 2011 debt ceiling crisis.  If the Chinese news agency Xinhua can publish a piece proposing a “new international reserve currency that is to be created to replace the dominant US dollar,” then something is afoot. Selling dollars en masse would be self-defeating – but diversifying into other currencies looks appealing."$USD&p=D&b=5&g=0&i=0&r=1382337262417

Richard Russell wrote in last week's Dow Theory Letters: "If the dollar breaks down it will be of great concern to all creditors of the U.S."

Victor Sperandeo commented on the implications of a sustained U.S. dollar decline:

"The Dollar Index has declined from July 9th 2013 intermediate high of 84.79 to the October 18th current minor low of 79.61. The key price levels are the July 2001 at 121.02 (the all-time high), and the 70.68 October 2009 low (the 73 year low of 46.23 was in December 1940).

The dollar is the world's reserve currency. As a result, all countries may hold a percent of reserves in dollars against their (demand) loans.  [The author notes that most emerging market debt/loans are denominated in US $'s.]  If the U.S. dollar declines sharply, the loans would have to be recalled or more $ reserves would be needed.  Such actions could cause the world economy to collapse.  In an attempt to prevent such a scenario, the Fed would be forced to raise short term interest rates, and stop printing money (i.e. end QE).  That would almost certainly trigger a deep recession.

Therefore, a U.S. dollar decline has a material Impact on world stability.  A break below 70.68 technically speaking would be critical. If the dollar index declines to 60.00, for example, the world could go into depression.  On the other hand, printing more $’s to support the greenback might result in hyperinflation.  Clearly, a no win scenario.

Recently, China has called for an end of the dollar as the world's reserve currency.  They want a "de-Americanized world."  No surprise, as China own $1.3 trillion of a declining asset which has no effective yield (i.e. T- Bills yield 3 bps).  If China sells their dollar holdings, it would be a real threat to the global economy.


Unlike export oriented Japan, the Fed does not want a deep decline in the U.S. dollar for the above reasons. This is why life will not be boring in the years ahead."


Closing Comment:

The CURMDGEON is perplexed, astonished, and bewildered by the current U.S. equity market.  We have never quite seen anything like it in over 45 years of being an active market participant.  That's because of the total decoupling between the market and the real economy.  The one thing we are sure of is that most "professional" money managers are underestimating the risks and erroneously believe that they'll be able to sell their long positions (to whom?) before any serious market decline.  Good luck!


Till next time.....................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.