Thursday, April 9, 2015

Resurrecting Global Bubbles?

Irwin Kellner, MarketWatch's chief economist, wrote a comment at the end of March, What will burst the stock market’s bubble?:
The consensus on Wall Street is that stocks will continue to rise ... until they stop. So the question now is: What can stop the market’s bull run?

This is especially pertinent in light of Monday’s surge. The Dow Jones Industrial Average gained a whopping 264 points to close at 17,976. This was the biggest increase in eight weeks.

The best way to answer the question posed in the headline is to determine what has not stopped the bull so far. Here are some items that come to mind:
  • Europe’s problems have not;
  • Greece’s issues have not;
  • China’s slowdown has not;
  • The Middle East has not;
  • terrorism has not;
  • deflation has not;
  • falling oil prices have not;
  • the strong dollar has not;
  • the Ukraine conflict has not;
  • domestic politics have not;
  • the Federal Reserve might — but a rate increase is already priced into the market.
That said, our central bank has been supporting the stock market to an unprecedented degree since the economy took a tumble a number of years ago, so any increase in rates might have some unexpected side effects.

Keep an eye on corporate profits. Expectations for earnings in the first quarter, which is now coming to a close, are not high to begin with. Most analysts are looking for little or no growth compared with last year.

But even these estimates could wind up being too optimistic, since many assume that the economy grew by 2% or more in the first quarter. But as I said in my column of March 3, the severe weather may have reduced the first quarter’s rate of economic growth by a percentage point or more.

That could take a big toll on profits. For example, if first-quarter earnings fell from their year-earlier levels, it would be the first four-quarter drop in six years.

What really makes traders nervous is that this market has not had a 10% correction in three years. The stock market’s rise last year was the sixth annual gain and the longest skein since 1999.

Stocks have risen this fast in six years only twice before: in 1993-99 and 1923-29. Both instances were followed by a bear market and a recession.

Until this happens, party on!
There are an unusual number of articles on stock and bond market bubbles popping up everywhere, which basically tells me things are getting bubbly all around the world, not just the United States.

The bubble that worries me the most is the China bubble. Bloomberg just published an article on how the world-beating surge in Chinese technology stocks is making the heady days of the dot-com bubble look tame by comparison. Nothing like a billion people speculating on Chinese tech stocks to drive up shares to the stratosphere! No wonder China bears are throwing in the towel.

The bubbles, or supposed bubbles, that worry me the least? The buyback and biotech bubbles everyone is fretting about as well as the bond bubble that Julian Robertson is worried about. He should listen to the new bond king, DoubleLine's Jeffrey Gundlach, to understand why this time is really different.

As for stocks, there are countless skeptics out there warning us that "by any objective measurement, the stock market is currently well into bubble territory," showing us terrifying charts like "The Buffett Indicator." It is a chart that shows that the ratio of corporate equities (stocks) to GDP is the second highest that it has been since 1950.  The only other time it has been higher was just before the dotcom bubble burst (click on image):

The only problem with "The Buffett Indicator" is that the Oracle of Omaha ignores it and recently stated in a CNN interview that stocks "might be a little on the high side now, but they've not gone into bubble territory."

So why are people so nervous? Well, there are a lot of reasons to worry but I think a lot of underperforming hedgies, financing blogs like Zero Edge which endlessly warns us of impending doom and gloom, have just read the macro environment wrong after the 2008 crisis. And they still don't understand that central banks around the world will continue to fight global deflation at all cost even if that means  resurrecting global bubbles.

Go back to read my comment on unwinding the mother of all carry trades, it's still alive and well. And as Sober Look notes in another excellent comment, demand for dollar funding in the Eurozone is likely to remain elevated as the area provides extraordinarily cheap financing while access to quality fixed income product has become increasingly limited. This just means the mighty greenback will keep surging.

So now all eyes are on the Fed. New York Federal Reserve President William Dudley said on Wednesday the Fed could still hike rates in June despite a weak start to the year, if economic data pick up over the next two months.

Sure, if the economic data improve over the next couple of months, the Fed will likely raise rates in June, but I agree with those who say it will be making a monumental mistake if it opens this window prematurely. Moreover, I agree with Brian Romanchuk of the Bond Economics blog, the Employment Situation Report for March was at best mediocre and there is no reason for the Fed to hike rates this year.

But don't discount a major policy blunder from the Federal Reserve which will wrongly interpret domestic and international data as a lot stronger than they truly are. That's what worries me and this is why I fear that deflation will eventually come to America, wreaking havoc on 401(k)s and private and public pensions.

Despite all these concerns, I'm sticking to my Outlook 2015, knowing full well that even though it will be a rough and tumble year, the opportunities still lie in small caps (IWM), technology (QQQ and XLK) and biotech shares (IBB and XBI) and the risks still lie in energy (XLE), materials (XLB) and commodities (GSG). 

A little warning to all of you playing the monster breakouts in iShares China Large-Cap (FXI) and  iShares MSCI Emerging Markets (EEM). Don't overstay your welcome no matter how tempting it might be thinking there is a global economic recovery underway. If the Fed does raise rates this summer, these markets will get clobbered.

Below, in a wide ranging interview with CNN, Warren Buffett discusses why stocks aren't cheap but they're not in bubble territory. The Oracle of Omaha also discusses his views on inequality and minimum wage. Fascinating interview, listen to his views.

Also, Tiger Management chairman and co-founder, Julian Robertson discusses the U.S. economy and bond bubbles. Mr. Roberston also thinks the U.S. dollar will continue to strengthen (second clip), which in my opinion buys the Fed time to stay put.

Third, while the Federal Reserve contemplates increasing interest rates, former Clinton Treasury Secretary Larry Summers said Thursday that policymakers should be more concerned about acting too early than acting too late.

Finally, take the time to listen to a discussion I had last week with Gordon T. Long of The Financial Repression Authority. I cover a lot of topics that others typically ignore, including how pension poverty is deflationary and will keep rates low for a very long time.

I am taking another long weekend to celebrate Orthodox Easter which is our most important religious holiday. I'm not a particularly religious person but I do enjoy this time of year and the church ceremony celebrating the resurrection of Christ.

"Kalo Pasxa" ("Happy Easter") and “Xristos Anesti!” (“Christ is Risen!”) to all my fellow Orthodox Christians (watch this clip featuring Irene Papas and Vangelis). Another clip that was sent to me over the weekend was one of Petros Yaitanos singing Christos Anesti. Enjoy!

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