Yesterday (October 22, 2013) I woke up to the headline on MarketWatch.com, “Stocks Open Higher On Fed Optimism After Tepid Jobs (number).” The inconvenient truth is that we live in a convoluted world where bad news is good news and good news is awful (for stocks). Even a government shutdown and potential default on U.S. sovereign debt, bad as that news was, could not derail the market. Eventually good news will be good news again, much to the chagrin of the bears.
I am ambivalent about the tone of the above title. I do feel Fed policy has been a key ingredient in the market resurrection form the 2009 lows. In the face of relatively restrictive fiscal policy, accommodative monetary policy has been a key to moving us to new highs in the S&P and Dow. Market perception about the course of Fed policy is a big deal. Michael Sincere’s “Don’t Fight The Fed–Fear it,” attempts to warn us about the dangers of too much money (Quantitative Easing) chasing after stocks, in particular a bubble and stocks.
Is this a Stock Market Bubble?
Is it too much money (i.e. QE) chasing stocks or non-competitve interest rates caused by QE that act as a magnet for equity investment? My bet it is the latter. The $85 billion coming off the printing press each month (half to buy mortgage-backed securities, half to buy long-dated treasuries) is not flowing directly to stocks; but, by keeping interest rates low, QE makes equities more attractive vs. bonds. Another important factor in keeping rates low is lingering fear and distrust of the market caused by the blow-up in 2008. All one needs do is take a look at the action of the U.S. Treasury ten-year note every time you get a scary headline (the flight-to-safety trade).
Mr. Sincere postulates that QE is creating a bubble in stocks. Sincere concedes, “Yes, it’s true, you don’t fight the Fed — at first. But the Fed is only human, and if it makes a mistake (which it’s prone to do on occasion), anything is possible. The Fed has got itself into a pickle this time. If it continues with QE indefinitely, it could cause economic damage. If it cuts QE, the market will protest.”
Don’t fear a major downdraft on the removal of QE!
Embrace it. It will be a normal event and for those who have been looking for a chance to get back in, it might provide a window. Remember, we have been through (up until very recently) a flat market since March of 2000. The Nasdaq index is still 20+% below its 2000 high.
Here are a few interesting metrics on the S & P, circa 2000 versus July 2013 (excerpted from session 49):
Date Close Earnings* Multiple* S & P yield 10 Year Tsy yld
03/24/00 1552.81 $53.47 29.04 1.16% 6.29%
07/19/13 1691.09 $106.46 18.43 1.90% 2.54%
10/22/13 1744.67 – – – 2.52%
* Multiple on trailing twelve month earnings
In the simplest terms S & P 500 earnings have doubled since March 2000, the dividend has increased 64% and it is now competing with a ten-year U.S. Treasury note that yields 2.54% (down 60% in thirteen years). The market is charging only 13% more than 2000 prices for those earnings and dividends vs. consumer price index inflation averaging about + 2.5% per year.
One last item, you have had a significant technical breakout above the 2000 S&P all-time high, leading me to believe we are in a secular bull market.
What do you think?
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