We had the S&P500 establish two successive all-time high closes this past week, with the Dow and NASDAQ each also again within shouting distance of setting their own new highs, as well. The calls continue that we must be topping out, that the markets can’t possibly go much higher, that stocks are getting way ahead of themselves, etc.
Well, actually, we don’t have to be topping out, we can go higher and stocks aren’t necessarily way ahead of themselves. Contrary to what is passing for conventional wisdom, while I obviously can’t be certain, it’s my firm belief that markets can go higher from here. While statistics can reveal an average where levels can/should eventually revert to, the stock market historically has actually spent little time near the average.
Bull markets don’t have to have “bubbles to stop” (see the 1950s as an example), nor are they locked into some magic timeline of longevity. I suggest that the economy is better than what the media would have you believe and that we still have more to go in a positive sense both in the markets and the economy.
The Federal Reserve Asset Bubble Machine (Not)
This was the title of an article in last Tuesday’s Wall Street Journal by Ruchir Sharma…except for the “not” part, that is. The short version is that Mr. Sharma believes that the “composite valuation for the three major financial assets in America – stocks, bonds and houses – is currently well above levels reached during the bubbles of 2000 and 2007.” He thinks that the Fed should pay attention to, if not worry about, the market prices of these assets. These, by the way, are not something the Fed has ever tried to control.
I think you can definitely make the case for bonds being over-valued right now but, as far as stocks and real estate, I think not.
First, let me address this whole (mis)perception that the Fed has pumped up the stock market through super-stimulative policies and artificially low interest rates and that all or most of this six year bull run will magically evaporate as interest rates begin to rise. While it’s true that the low rates have caused investors to focus more attention on stocks to provide the returns they formerly could get from fixed income issues, I don’t see how the Sharmas of the world – and there’s lots of them – don’t seem to get that these policies have not been stimulative to the economy or these assets.
What the Fed has done these last few years is to simply respond to the overdone amount of risk aversion in the global markets. They haven’t simply “turned on the printing presses” and created lots of dollars. Gold moved way high on the assumption that this would create huge inflation but, with the yellow metal now well into the third year of a bear market of its own, it sure doesn’t look as if this inflation is anywhere on the horizon.
What the Fed did do was to swap bank reserves for Treasury Notes and Bonds to help meet the demand for money in this risk-averse environment. These reserves aren’t out “floating around” in the economy; they’re still being held in banks. That is not hardly a stimulus.
Consider this instead
US corporate profits have been at record levels for the past few years – and continue to rise. Seems to me that this can certainly justify higher price-to-earnings (P/E) ratios.
If we were in a “normal” rate world, the 10 year US Treasury Note would likely be a lot closer to 4% than the 2.25% it’s currently paying. If you check, stocks today are at about the same relative valuation as they were in the 1960s when the 10 was at 4%. So, I believe that this reinforces the fact that the stock market isn’t over-valued; it’s simply trading as if rates will be a lot higher in the future. The markets are pretty smart that way…
As for housing, a low supply of new or existing homes has helped to move the average home prices higher. But even now, national home prices are still about 25% below where they were in 2006, at the peak. Further, a 30 year mortgage was at 6%, or more, while there are a number of lenders still at about 4% for that same loan. This combined lower cost of purchase and financing says that, instead of being too rich, looks to me as if housing is a lot more affordable than at the peak. Hardly bubble territory.
You don’t need the Fed or tsunamis of new money to make stocks go higher. The Wall Street Theory of Relativity is all based on either “better than” or “worse than”. So, as we saw prior to this recent earnings season, most analysts and strategists were quite down on expected earnings. Then, when their fundamentals actually came in “better than expected”, stocks continued to rise.
We’ll continue to see generally positive market moves until the majority of the reports come in as “worse than expected.”
With the massive wall of worry still very much out there, “worries” about everything and expectations for the economy and companies continues low, historically, it would appear that we have a really long time to go before we need to be looking for shelter.
Unless something momentous happens in the markets this week, we won’t be having a letter over Memorial Day. Nonetheless, please remember what Memorial Day is really for as you enjoy the long weekend.
To absent friends.
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