A stock market living beyond its means
Stocks are not cheap and the economy is still weak, says this U.S. advisory, so investors can expect the market rally to hit the wall.
This is not the golden age of conservative investing.
We have been mired in a crisis brought on by exorbitant debt and a mass of murky derivatives that sucked banks, insurance companies and others into a financial quicksand.
The stock market crashed and then recovered to go on a high-flying rally that is bound to make any cautious investor nervous.
Analysts, central bankers and media types unleash an unending series of conflicting opinions on what we can expect next.
To take the pulse of the markets, there is one source we can turn to that never errs on the side of optimism. Quite the contrary.
Bob Carlson’s Retirement Watch is one publication in which we invariably find a conservative point of view. This American advisory preaches risk management and preservation of capital.
The holiday season may be approaching in the U.S., but Mr. Carlson is not about to spread good cheer about this long market rally.
Stocks are not cheap, he says, and the economy has not really recovered.
Overbought territory
In the last few months, says Mr. Carlson, investors “have shrugged off some disappointing economic data to push asset prices higher.”
All well and good, he says. But the stock market is not as strong as the gains since last March might imply. For one thing, trading volume is low, much lower than it was during the market’s decline in 2008.
Long-term bull markets always kick off with high trading volume. In fact, more investment money in the U.S. is flowing into bond funds than into stock funds.
“The markets continue to venture into ‘overbought’ territory,” the editor adds, “with a high percentage of stocks selling above the 50-day moving averages of their prices, and the indexes are substantially above their 200-day moving averages.”
There is another technical reason to be cautious, he says. Analysts are more bullish than they have been in two years, according to the Bespoke Investment Group. Watch out below!
Down this road before
Mr. Carlson cites Mr. David Rosenberg, the widely quoted Canadian analyst who once held court at Merrill Lynch, and is now back in Toronto at Gluskin Sheff.
Not only are stocks not cheap, Mr. Rosenberg says, they are now the most expensive they have been in a seven years. We are at risk of a 2007-like high.
“We’re not momentum investors and won’t chase a market controlled primarily by momentum investors,” says Mr. Carlson firmly. “We’ve been down this road before, when the current mood of investors is out of line with fundamentals and our risk comfort level.”
Someday, prices will come back to that comfort level. But not yet. “A rising stock market is supposed to be forecasting an economic recovery, but we don’t see signs of a strong recovery,” he says emphatically.
No real economic activity
There is good news in the economy, Mr. Carlson admits. Most of the immediate strain on the U.S. banking system has been relieved. Key parts of the economy are bottoming instead of falling further.
Interest rates are low. The spread between high yield bonds and treasury bonds is lower. Rising asset prices have sharpened up the balance sheet for both banks and households.
But all the liquidity that has been pumped into the system has not stimulated “real economic activity.”
Consumers are not spending the economy back to health. And the problem remains the same. Debt.
American households still have high debt-to-asset and debt-to-income levels. They are saving and trying to beat down debt.
Mr. Carlson has followed the credit markets closely. He looks at the asset-backed securities (ABS) markets, consumer borrowing, bank lending and corporate bonds.
Decline of the dollar
The ABS markets spurred on economic growth over the past decade. They froze in 2008, and now they depend on government spending. And even though bank lending is up, it is really a matter of businesses shifting their borrowing from the ABS markets and bonds to banks.
It does not signify more credit pouring into the economy. Smaller businesses are particularly starved for credit. Almost all mortgage lending is government-backed.
“It is not clear how long the Fed and government backing can continue because of the steady decline of the dollar,” says the editor. “While U.S. investors have enjoyed a nice rally in stocks, international investors aren’t doing as well after converting their profits back into their home currencies. The surge in gold to record prices also is a clear sign global investors are wary of the dollar.”
At some point, the Fed and the federal government may have to change their policies dramatically.
The message is clear, in Mr. Carlson’s opinion. With so little real economic activity and so much debt, the market is living beyond its means.
“The momentum will stop when the economy fails to meet expectations,” he concludes.
Note he didn’t say “if,” he said “when.”
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