Bubble Anxiety On the Rise?
Markets have left milestones for dust. US stock prices are enjoying their best year since 1997, with investors apparently untroubled by the backdrop of a lacklustre economy and high unemployment.All of a sudden, everyone is jumping on the bubble bandwagon. Just click here to check out the latest news on the stock market bubble.
The S&P 500 has barrelled through three century marks this year alone, from below 1,500 to this week’s intraday peak of 1,802 for a year-to-date gain of 25 per cent. The Dow Jones Industrial Average has finally breached the 16,000 threshold, after rising through 15,000 in October, while the Nasdaq Composite is looking to revisit 4,000 after an absence of 13 years since the dotcom bust of 2000.
As the Fed’s balance sheet approaches $4tn, its expansion in recent years neatly matches the rise in the S&P 500, creating unease that an equity bubble is surely inflating as was the case in 2007 and 1999.
Not so according to Janet Yellen, Federal Reserve chair-designate, who told Congress last week that the central bank does not see a bubble in equities based on the metrics of equity risk premium and price to earnings ratios. Ms Yellen also said there is no federal rule to support the stock market.
But in the absence of a strong economic recovery matched by rising incomes, this year’s rapid rise in equity prices is also seen reflecting the activist role of the Fed as it buys $85bn of bonds each month, suppressing interest rates and forcing investors to buy shares, corporate bonds and real estate.
While some investors argue the stock market has not reached a valuation tipping point, the concern is that unless the broad economy and incomes accelerate soon, the prospect of a major correction in equity prices looms.
“Even the most bullish investor would admit that sluggish economic growth, a lacklustre labour market, and political discord are hardly the logical bedfellows of a stock market at new highs,” says Nicholas Colas, chief market strategist at ConvergEx.
“The current market action of a year end melt-up coming after five years of truly solid returns for US stocks, seems at first blush to be irrational performance-chasing. And who knows, it may end up being exactly that.”
Certainly the return of money into US stocks after outflows in 2011 and 2012 has been one catalyst for outsized performance. According to Lipper, investors have pumped a net $285bn into US equity mutual funds and exchange traded funds in 2013, the best year for the market since their records began in 1992.
Among the winners, FedEx, Google, Amazon and Microsoft have rallied 40 per cent or more, while companies such as IBM and Apple are modestly negative in 2013.
Countering the concern of a bubble forming, barometers of the economy such as transport and small-cap stock benchmarks are up more 30 per cent this year, reflecting a general consensus of accelerating growth in 2014.
Richard Madigan, chief investment officer at JPMorgan Private Bank, says the current forward P/E multiple on the S&P 500 at about 15 times is well below the reading of 24 times seen in 1999 at the tail-end of a major bull run.
“From a historical perspective, that is roughly what we consider to be fair value. Looking ahead, animal spirits still seem ambitious, but neither hubris nor complacency has currently taken over investor behaviour.”
At the very least, with the Fed set to taper in the coming months, there is a concern that the market’s hefty gains in 2013 have borrowed from the future, particularly as revenues are expanding modestly for many companies.
“The current rally has robbed a bit of next year’s performance,” says Michael Kastner, managing principal at Halyard Asset Management.
Mr Madigan says: “Investing is going to get more complicated as most of the easy overweight investments have just about played themselves out.”
A looming question is whether some investors will take the opportunity to lighten equity exposure ahead of the taper and fiscal battles in Washington.
Tobias Levkovich, US chief equity strategist at Citi, still believes in the secular bull market, but says: “The market is vulnerable to a pullback here; if profit-taking sets in, no one wants to be the last one out of the door.”
As the equity market looks to chalk up more milestones in 2013, the worry remains that the new peaks could become a millstone for late bull run arrivals.
Mr Kastner says: “We seem to have moved from investing under sensible valuations to one of the greater fool theory, hoping there is another buyer willing to pay a higher price at these extended levels.”
It's actually quite comical reading some of the headlines. For example, Robert Lenzer of Forbes argues there can't be a stock market bubble in a stagnant economy. Really? That's news to me. In case you haven't noticed, global stock markets don't care about what's going on in the real economy.
In fact, as Jonathan Nitzan and Shimson Bichler so eloquently argue, capitalists and pensions can't afford a recovery. Capitalism thrives on inequality and nowhere is this more evident than the schism between the real economy and the financial economy. And as I told you last Friday when I went over the holdings of top funds during Q3, if you think 1999 was crazy, get ready, you ain't seen nothing yet!
The perverse effects of quantitative easing have punished savers and rewarded speculators. Astute readers of my blog will remember that over the last few years, I've been warning investors to get ready for the mother of all liquidity bubbles. I've repeatedly warned you the power elite will do whatever it takes to reflate risk assets and err on the side of inflation.
Forget Grexit, the euro crisis, Arab Spring, the U.S. fiscal cliff and never ending debt ceiling debacles, these are all circus shows which the media play up to instill fear on the masses while elite hedge funds and bank prop desks keep buying every pullback hard.
In fact, two years ago I discussed how extreme volatility is confounding investors, stating the following:
...as I stated in my previous comment on withering risk assets, I remain positioned for La Dolce Beta and think that money managers and asset allocators are not reading the macro environment properly. Pensions in particular should be capitalizing on this extreme volatility by taking opportunistic positions in risk assets. Unlike hedge funds and mutual funds, pensions have deep pockets and long time horizon to take opportunistic bets. Problem is most of them are too busy chasing after hedge funds or worrying about Europe, which is why they too are victims of extreme volatility.And in March of this year, I discussed confusion over volatility strategies, stating the following:
...getting back to these tail-risk hedging strategies, I've covered this topic last year in a comment on hedging against disaster, noting the following:And now that fears of Grexit and a euro crisis have dissipated, investors are getting greedy again, chasing all sorts of risk assets, not just stocks. While everyone is fixated on whether stocks are in a bubble, the reality is there are bubbles sprouting up everywhere, including high yield bonds, leveraged loans, private equity, infrastructure and real estate. There are housing bubbles all over the word and the newest bubble is bitcoin, the alternative currency which has soared in value (Richard Branson is riding the bitcoin surge into space. Need I say more?).
The market hasn't "priced in" a eurozone break-up for the simple reason that it won't happen. All these hedgies waiting for a "Lehman-style event" so they can score big are collecting 2 & 20, selling fear to their institutional clients.Well, it turns out I was right, all the managers that took a risk-off approach fearing the end of the world are the ones that underperformed most in 2012. Meanwhile, a few brave investors and a small Greek pension fund that nobody has ever heard of made a killing looking well beyond Grexit.
The biggest and most powerful hedge funds in the world stand ready to pump up the jam. The black swan of 2012 remains a mild eurozone recession. When fears of a eurozone break-up dissipate, greed and massive liquidity will drive all risk assets much, much higher. That remains my prediction, and if I am wrong, God help us all!!
In fact, according to the latest Bloomberg Global Poll, asset bubbles are forming in Internet and social media stocks as well as in the housing markets of London and China. This is creating quite a bit of angst among investors who do not want to chase yield at any cost.
The problem is while some of these bubbles will pop before others, it's impossible to predict when this will occur. Investors betting against central banks have taken a beating and they'll continue to get clobbered as we move into the parabolic phase of the stock market bubble. There will be pullbacks but they'll be bought hard.
In fact, big banks are awash with cash and they're speculating on risk assets now more than ever. never mind the increased regulations, Basel III, the Volker rule, etc., the amount of money prop desks are making is obscene.
And now that there is talk of tapering, what did U.S. financials (XLF) do yesterday? They rallied hard and propelled the stock market into record territory. Banks will make a killing off spreads if the long end of the yield curve widens relative to the short end. Remember, banks profit off money for nothing and risk for free.
I still like U.S. banks and think they have better prospects going forward relative to their Canadian counterparts which recently surged to record territory (book your profits). All this talk of Fed tapering is premature and it won't happen until emerging markets are on more solid footing.
Importantly, the Fed and other central banks are still more concerned about deflation than asset bubbles. They will do whatever it takes to reflate risk assets and stoke inflation expectations all around the world. The last thing they want is an emerging markets crisis which will reinforce deflationary expectations.
On that cheery note, enjoy the stock market bubble while you can. If you're a conservative investor, focus on solid companies with little to no debt that offer attractive dividends, but beware, all these interest rate sensitive stocks can get clobbered if rates start rising fast once again. The same goes for high-beta stocks which move up fast and coming crashing down hard when the algos go to risk-off mode.
My best advice for skilled investors is to look carefully at the Q3 holdings of top funds, there are some gems in there. And while some sectors are bubbly, others are not, and when you look at individual companies in all sectors and industries, there are tremendous investment opportunities. Despite all the talk of froth, there are plenty of great investments for stock pickers (it's not all just about beta).
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Below, Adam Johnson, Julie Hyman, Olivia Sterns and Cristina Alesci go over top market stories on Bloomberg Television's "Street Smart" and discuss how bubble anxiety is on the rise.
And David Tepper, the hedge fund manager who runs Appaloosa Management LP, talks about the performance of U.S. equity markets, outlook and investment strategy. He speaks with Stephanie Ruhle at the Robin Hood Foundation's investors conference on Bloomberg Television's "Street Smart," discussing why stocks are not in a bubble.
Tepper has played the Fed put perfectly, making a fortune in the process. There will be a time when he too will get clobbered and fall from hedge fund grace, wiping that smug smirk off his face, but for now he and other hedge fund "legends" betting on risk assets are riding the beta wave higher and having fun flirting with Stephanie Ruhle (can't blame him).
Finally, David Einhorn, Greenlight Capital co-founder & president. Einhorn weighs in on the Fed and the market rally; and discloses where he is short. You can track Tepper and Einhorn's latest holdings and many other hedge fund gurus by looking at my recent comment on the Q3 holdings of top funds but take everything they say publicly with a shaker of salt.