by Lance Roberts of STA Wealth Management,
The comedian Louis CK has a great bit in his act called "Of Course. But Maybe..." that explores the good and bad thoughts that exist within the human psyche. I have posted the clip below for your viewing pleasure. > {Disclaimer: I do not endorse or support any views that may be found offensive. Of course, I do...but maybe...}
It is in this context that I wanted to discuss a recent article by David Goodboy entitled "2014 Promises To Be Another Bullish Year."
As he opines:
"I love it when the stock market bears crawl out of their caves. The louder they get about an imminent market crash, the more confident I become that it's not going to happen anytime soon."
Of course, 2014 is going to be a good year because of the "Wall Of Worry"
"When everyone is super bullish, that's when it's time to expect a market correction. Even the bears have a name for this phenomenon: climbing the 'wall of worry.' Stocks are said to be climbing the wall of worry when they are acting the opposite of what the bears expect. Certainly, there will be pullbacks and even a few sharp drops in every bull market, but I expect the long-term upward trend will remain in full effect well into 2014."
But Maybe...
Everyone already is super bullish, and a Bob Farrell's Rule #9 states: "When everyone agrees something else is bound to happen." The chart below shows the bullish sentiment of professional investors versus the S&P 500. It is important to notice that peaks in bullish sentiment normally coincide with both minor and major corrections in the markets.
Another way to view bullishness is through the use of "leverage" to increase portfolio returns. The more "bullish" investors become; the more "risk" they are willing to take on. A good way to look at this is by viewing the level of margin debt as compared to the level of negative cash balances as shown in the chart below.
Currently, investors all "all in."
Of course, 2014 is going to be another bullish year because of cash inflows:
"The stock market is controlled by buying and selling. These so-called inflows and outflows of capital are what determine stock prices. Investors transferred $12 billion into stock funds in just the final week of November, according to Lipper, the largest increase in five weeks. Funds specializing in U.S. stocks attracted $8.9 billion of these inflows, while non-U.S. stock funds absorbed $3.1 billion."
But Maybe...
The chart below shows the push by individual investors into retail equity mutual funds. It is really a testament to what we already know which is that historically investors tend to do the opposite of what they should – "buy high and sell low."
As I discussed in "Third Stage Of A Bull Market" investors tend to go through three distinct psychological stages during the "Bust To Boom" phase: 1) Disbelief, 2) Acceptance, and; 3) Exuberance. The problem with David's argument is that he is assuming that individual investors have some knowledge about the future of the market and are making a rational investment decisions. However, the reality is that low rates are forcing investors to take on more risk than they realize as they chase returns. In other words, "everyone is now in the pool."
Of course, 2014 is going to be another bullish year because of the Federal Reserve:
"Think of the Federal Reserve as the wizard behind the curtain. The world's most powerful central bank sets the economic tone by tightening or loosening monetary policy. Its powers include its command of interest rates and an entire host of quantitative tools to spark or slow economic activity. The Fed is showing zero sign of ending its QE program anytime soon and has said its decision to start tapering depends strictly on the economic data...With interest rates near zero, and the Feds unlikely to start tapering until well into 2014, the stock market has no place to go but higher.?"
But Maybe...
I do agree with David's point that the Fed is responsible for artificially inflating asset prices. As I discussed in "Bernanke/Yellen To Drive Stocks 30% Higher:"
"At the current rate of balance sheet expansion, and assuming that correlations remain, the markets could well rise to 2329 by the end of 2015. This would also mean the Fed's balance sheet would have also expanded beyond $6 Trillion. This would likely imply that the Fed would own more than 50% of the treasury market."
The problem, potentially, is that individual investors are, as discussed above, piling into equities under the belief "this time is different." In 1999, it was the "tech boom," followed in 2007 by the "real estate/credit boom." Today, it is the inherent belief that the "Fed's accommodative policy" trumps all other issues.
What we do know is that the Fed has embarked into a dangerous game of "bubble blowing" in the hopes that the bubble can be deflated without impeding the economic recovery that it created. This has never been the case previously and is unlikely to be the case presently.
The majority of the arguments for a continuation of the bull market have given way as interest rates have risen, valuations have climbed and earnings and revenue have slowed. This has left the Federal Reserve's ongoing monetary interventions as a main driver of stock prices. However, that could change with President Obama considering a hawk, the former Bank of Israel chief Stanley Fischer, to become the vice chairman of the Federal Reserve.
When asked in an interview about when the Fed should begin tapering $85 billion in monthly bond buying, Fischer replied that:
"There is an efficient way to do it, which is to start doing it pretty soon and to do it gradually."
Despite Wall Street hopes for ongoing infusions of liquidity in the financial markets; the drumbeat of "tapering" is growing louder.
Of course, 2014 is going to be another bullish year because of corporate earnings:
"...the recent upward move in PMI is indicative of earnings growth soon to follow. This is signaling that we should soon experience an overall improvement in earnings in the first quarter of 2014."
But Maybe...
Since the financial crisis, top line revenue has grown only 1/10th as fast as corporate profitability of which the latter is already at a historical peak. The chart below shows the deviation in corporate earnings from their long term historical trends verses the market.
I discussed the problem with the current earnings cycle in "Analyzing Earnings As Of Q3 2013" wherein I stated:
"The ongoing deterioration in earnings is something worth watching closely. The recent improvement in the economic reports is likely more ephemeral due to a very sluggish start of the year that has led to a 'restocking' cycle.
The sustainability of that uptick in the economic data is crucially important if the economy is indeed turning a corner toward stronger economic growth. However, with the Affordable Care Act about to levy higher taxes on individuals, it is likely that a continuation of a 'struggle' through economy is the most likely outcome.
This puts overly optimistic earnings estimates in jeopardy of be lowered further in the coming months ahead as stock buybacks slow and corporate cost cutting becomes less effective."
Could we have another bullish year in 2014? It is certainly possible as long as the Federal Reserve remains engaged in their ongoing balance sheet expansions.
But maybe the ongoing inflation of assets, without the underlying improvement in organic, sustainable, economic growth, will eventually lead to the next market bubble and bust. Of course, for anyone that has payed attention, such an outcome would be of little surprise.
The important point is that, as an investor, you need to pay attention to the ever decreasing reward/risk ratio of chasing the financial markets. The "low hanging fruit" has long been harvested and the risk currently far outweighs the potential reward of being aggressively invested.
I realize that it is not popular, or fun, to rain on David's bullish parade. However, while he will likely appear to be correct in the short term; the long term outcome will most likely be far less pleasant.
