Well it is true that the Dow and S&P500 are approaching all-time highs. But this is not so for Europe, Japan (which is finally coming out of an underperforming stock market), nor for resource heavy Canada and Australia. But yes the U.S. has experienced some pretty good appreciation. In August 2011, this blog did a quick analysis of bull and bear markets going back to 1932. We learned that the average stock market rise after bottoming ranges from 20 to 142% and averages 72%. The Dow bottomed in February 2009 around 7065 and an average subsequent rise would make it peak at around 12690. If we were experiencing a 140% rise then the Dow should peak around 16920. These are of course very crude numbers, but you can see that several experts have taking note of the substantial rise of the Dow.
The time it typically takes from bottom to peak is between 2.3 and 5.1 years – with the shortest time being just a quarter (3 months). And we were worried about a double dip! Thus, since we bottomed around February 2009 then we are now due for a crash. For 5 years now, investors have climbed a wall of worry and now they are becoming increasingly bullish and don’t want to be reminded of the rough years that preceded today’s ‘good market’ feeling. One could speak of a starting mood of Euphoria in the U.S. markets and things start looking up big time with a housing market on fire in parts of the U.S. Also, Mr. Ben Bernanke has been greasing the economy with quantitative easing and record low interest rates.
Yet we have not achieved Bernanke’s stated targets of 6% unemployment and inflation is not exceeding 2%. Most Pundits feel that that is still a year or two away. Yet, others start to worry about ‘tapering down’ the bond buyback programs pioneered by the U.S. Central Banks and copied by Europe and lately by Japan. Government debts have been ballooning and gold bugs have predicted sky high inflation and sky rocketing gold prices which have not materialized (yet!). There is no doubt that western governments will not be able to repay their debts, but as pointed out in an earlier post, it has never in history been the intend of governments to repay their debts. In the end they will inflate their debts away. Quantitative easing is nothing more than inflating and devaluing the U.S. dollar which results in reducing debt as a percentage of GDP!
So, yes we’re looking at the return of inflation, the devaluation of government debt and increased asset prices such as recovering real estate, stock market and even art, gold and silver prices. In my opinion the U.S. markets are in the latter stages of a bull market when prices rise to exuberant levels. That does not mean a crash is eminent, but it is a time to become cautious on buying U.S. stocks. Also, the U.S. economy and government have the wind in their back thanks to the energy revolution. The U.S. government has just issued another permit to export LNG (natural gas). Their oil production has been sky-rocketing and they don’t know what to do with the associated gas they produce along with the oil – so they flaring it off! With so much energy, the U.S. does not need to import that much oil and gas anymore thus reducing their dependence on foreign suppliers and… reducing the trade balance and federal debt!
Other stock markets, in particular commodity based stock markets, have fared much less well than that of the U.S. because overall economies, including that of the U.S. have not particularly been booming and neither has market psychology improved a lot in most markets. Now, it should be understood that stock market performance is not directly related to economic performance. Apart from the psychological mood of investors, stock markets over the long run are driven by corporate earnings and that makes up a significant but not the major part of an economy. It is not without reason that many income earners in western economies work typical 6 month or longer to pay their taxes each year. Thus government makes out a very large part of the economy as well, just ask the French :).
I suspect that the U.S. market is in for a breather. But other markets will have better days ahead. So, these warnings about a crash coming soon in a market near you are a bit exaggerated. But not so much that we should ignore these signs of topping markets. There are lots of questions out there that cannot be answered, in particular about the reliability of Chinese economic data. However, if an economy of barely the size of 25% of the U.S. could affect commodity prices in the 2000-2008 years when it grew at 10% per year, then the world’s 2nd largest economy of 2013 growing at 7 to 8% should help increase demand for commodities as well – even if this second largest economy happens to a be ChinaJ. The European debt crisis has all but blown over and the rising European stock markets indicate a recovery in the making.
The evidence of markets becoming gradually more euphoric can be found in investors abandoning gold. This is probably a mistake. If fiat currency represents the cash in investor pockets that is backed by highly indebted governments, then gold is the universal currency not affected by government debt and that should be the most reliable form of cash. So in a world where we expect stock markets to achieve a state of euphoric optimism over the next year or two and with an ever declining level of confidence in fiat currencies, gold may become the preferred denomination of cash.
That is what our investment strategy should be aiming for the coming year or two: take profits in our stock holdings, prepare for inflation by accumulating assets and if too expensive to buy said assets then build up your cash holdings (a combination of gold and short term liquid money market funds which will protect you a bit against inflation). Using an analog from past blogs: the stock market traffic lights are mostly on green, one more light that switches and things get euphoric. At that point, the lights can only switch to red.