Financial Markets after the Government Shutdown; Postmortem, a review…

  • Written by David
  • November 12, 2013 at 2:34 am
  • 0
  • Some observations I have inked in the past few weeks, since the Government shutdown in October 2013.

    I thought I would reflect on the global financial markets ‘picture’ since the U.S. Government shutdown in October. Here’s a post mortem on the markets since Congress ‘fixed’ everything on the 17th of October.

    Govt. Paralysis

    How odd that only a few hours after the ‘fix’ for the government shutdown for what, 2-3 months, the politicians are at each other again on the website rollout. I can only imagine what they will do when we have to deal with this budget/debt ceiling all over again in Jan/Feb 2014.

    So what has happened since the 11th hour fix a few weeks ago?

    GDP Growth

    From the perspective of the US/Global Economy.. Economies continues to show signs of further slowdown.
    (and that’s before the approximate 1/2 of one percent, or more, that will be shaved off fourth quarter GDP due to the govt. shutdown.)

    Market Valuations 

    But meanwhile, market valuations continue to rise on the hope of continued money printing by the Federal Reserve. Markets rally (go up) when we get bad economic data because it means the Fed will continue to print money.  Do you remember playing Musical Chairs at school carnivals? All is fine while the music is playing. It will be tough to keep these valuations up once the ‘money printing’ slows down/stops. (i.e. when the music stops)

    As you may recall, global stock markets retreated 5% to 20% last spring when the Fed just ‘thought’ about the idea of printing less money as shown here:

    Longer term bonds got clobbered during this time frame as well:

    This will happen again.

    A quick view of today’s overvalued markets:
    We are the yellow dot on the graph right now:

    another view here:

    There is talk of a new bull market that is starting. Unfortunately bull markets don’t start until P/E ratios are single digits (refer to following chart; note 1982 at 6.6X earnings-that’s when bull markets [rising mkts] start.) We are at over 22.5X right now, as shown in the same chart from above.

    We are in the late stages of this current rising market; not the beginning.

    When you subtract out the financial stocks, the market looks just miserable.

    Remember, financial institutions are the net beneficiaries of some $400 billion per year of free money.. since they can borrow at zero interest rates and not pay interest on deposits, money market accounts etc.

    “There is a $400B per year, wealth transfer from everyday Americans 2 banks due to #QE @JamesGRickards on @BBC_Analysis”

    Bottom-line, markets are continuing the ‘topping out’ process. Of course it is holding on longer due to the Fed’s printing money as shown here:

    Below, Central Bank balance sheet growth, over the past five years, vs G-5 GDP growth. It would appear QE, ‘money printing’ is not achieving the intended result, economic growth.


    Topping out processes are painful to watch as an advisor as individual investors pile in at the top:

    This is no different from 1999, 2006-07.

    Once Again, Retail Investors Are Piling Into a Bubble Near the Top

    “One of the best means of gauging investor sentiment for individual investors pertains to how they move their money in and out of mutual funds.

    For example, from 2007 until the end of 2012, investors pulled over $405 billion out of stock based mutual funds. Over $90 billion of this was pulled in 2012 alone: the largest withdrawal since 2008.

    In contrast, over the same time period, investors put over $1.14 trillion into bond funds. They brought in $317 billion in 2012: again, this was the most since 2008.

    This marks quite a reversal of asset class fund flows: before 2008, stock funds usually took in $2 for every $1 investors allocated to bond funds.

    However, this trend reversed back to normal in 2013. The Fed finally succeeded in inducing investors to move into stocks again. And they have done so in a big way. Thus far in 2013, investors have put $277 billion into stock mutual funds.

    This is the single largest allocation of investor capital to stock based mutual funds since 2000: at the height of the Tech bubble. That year, investors put $324 billion into stocks. We might actually match that inflow this year as we still have two months left in 2013.

    Indeed, investors are reaching a type of mania for stocks. They put $45.5 billion into stock based mutual funds in the first five weeks of October. If they maintain even half of that pace ($22.75 billion) for November and December, we’ll virtually tie the all-time record for stock fund inflows in a single year.”

    Source: Phoenix Capital

    And let’s not forget margin debt, its back in a big way, highest its been (percentage wise): This shows speculation in the markets

    Corporate Profits

    As GDP declines, so have earnings forecasts.  Profits, however, have ‘decoupled’ from GDP growth. Profits have been supported by layoffs, stock buybacks, what we call ‘financial engineering’; not good old sound top-line revenue growth, and product sales which create capital expenditures, R&D, job creation and ultimately strong earnings from core business operations.

    Earnings growth is flat, most of the stock market moves have been from higher valuations of P/E ratios: P/E Ratios generally only rise when future earnings are expected to be higher, inflation lower, and overall, a greater certainty about the future.


    Today, it is mere speculation on continued money printing that is driving PE Ratios, not earnings.

    New Fed Chairperson

    Let’s not forget we get a new Fed Chairperson next year: Historically this tends to be disruptive to markets,

    What Others are Saying

    More sage investors are stepping up to talk about how overvalued the markets are due to fed printing. What these folks are saying is what I have been talking about with you for some time. This chorus is growing as the fed continues to feed the current asset bubble. Must say, it is nice to have a little more company on the subject.

    A worthy 3 minute interview with Mark Spitznagel (President and CIO of Unversa Investments LP [a hedge fund] and author of The Dao of Capital). Spitznagel offers salient views about today’s markets in this 3 minute CNBC interview. But before you view the clip, note that his hedge fund was up over 100% in 2008 while the S&P 500 index was down over -38% that same year…”the market is setup for a major crash”, current market “entirely artificial” environment driven by zero-interest-rates and central bank asset purchases, along with valuations and sentiment, has distorted the ‘markets’ in the same way as “in all other major tops in history.”"His investing advice is simple, “step aside!” But doesn’t expect many to heed his proven advice, because, “it is the hardest thing to do right now, “and makes you look like a fool.”

    A weak economic report lifted an overbought equity market to even-loftier historic highs. Investors and traders have become programmed to believe that QE (rather than economic growth) is enough to launch asset prices ever-higher. At the moment, there is little to refute this view. “Melt-up” mentality is back. However, shouldn’t a sluggish economy with slow job creation make investors question whether enough economic activity will be generated to justify prices? Unless the economy improves materially, then today’s move is just another example of speculative excesses caused by QE.”Guy Haselmann of Scotiabank

    “In the meantime, the markets have apparently decided to ignore the problems and concentrate on what the Fed does. That will work until it doesn’t and I have no idea what will cause investors to once again concentrate on fundamentals. When they do, what they find won’t be pretty. Weak economic growth, weak revenue growth and weak earnings growth don’t bode well for a market trading at an above average price. So far, nothing has been able to knock down the bull and rumors of its demise – including from yours truly – have proven at best premature. I would just urge all investors to think about a full market cycle rather than just the bull portion. At some point, reality will intrude on the perpetually bullish and the downside to current prices is probably considerable.”

    Wealth Management Firms Look to Hard Assets For Next Price Boom
    Posted by Steven Maimes, Contributor – on October 21st, 2013
    NY Post article by Gregory Bresiger
    As equity markets hit all-time highs again, investors haven’t forgotten the 2008 market meltdown that resulted in a 40 percent loss.
    And now they are prodding money mangers to help protect them against another one.
    To accommodate the well-heeled investors’ cautiousness, money managers and advisers are diversifying assets away from the bubble-prone stock market and into alternative assets like real estate, commodities and sometimes mutual funds that can short the stock market.

    It is a trend that many asset managers see continuing over the next few years, several market-research firms say.
    “Alternative products are attracting interest from retail and institutional investors, as both are increasingly looking for portfolio diversification, enhanced returns and risk management,” says Michele Giuditta, associate director at Cerulli Associates, a securities-industry consultant.

    And the most important reason for this move by big asset managers away from stocks has been the need to diversify investments, says a study by Strategic Insight, another market-consulting firm.

    Summary and Conclusions

    • Weak economic growth
    • Weak revenue growth
    • Weak earnings growth
    • Corporate profits at an all time high
    • Overvalued markets
    • Government dysfunction-here and abroad
    • Fed printing money with no visible exit strategy
    • Asset price valuations ‘hooked’ on QE money printing
    • Unknown factors due to Govt. dysfunction; ACA rollout, budget, deficit, sequester etc


    More investment professionals are beginning to say that stock markets are overvalued (as much as 30% to 40% or more). If this is true, (which I agree on) then when the markets do correct, they won’t simply go from today’s overvalued state to ‘fair value’. They will blow right past ’fair value’ and go to undervalued status. I have no idea (nor does anyone else) where that undervalued price is. But with dry powder, (cash, short-term investments, low volatility strategies and alternative investment strategies) as Mark Kpitznagel says in his 3 min interview, one has the ‘position of advantage’…(I like that quote.)  We can take advantage of the next market downturn; no panic, no trauma. Just the opportunity to select investments at proper valuations, when the time arrives.

    Asset Allocation Strategies

    What’s working right now in the markets:

    • Owning risk assets..stocks
    • Being out of cash and short maturity assets
    • Being out of alternative assets, gold, and most other alternative assets


    What’s not working in the markets right now

    • Cash and short maturity assets
    • Alternative assets, gold
    • Not being in risk assets-equities


    What will be working once the correction process starts

    • Cash and short maturity assets
    • Alternative assets, gold
    • Buying equities after the correction, at a significant discount to current prices.


    As I have stated many times over the past few years, the Fed (Central Banks) has/have created a casino for the equity markets, and to an equal extent, that for longer term bond markets. I have no rational reason to own certain asset classes right now based on today’s valuation, or own them for much longer.

    So what are the ‘alternatives’ to traditional markets if they are overvalued? Enter……

    An ‘Alternative’ to Traditional Stocks and Bond Investing

    Go here to launch that page:

    I continue to look at many asset classes; I am ready to own a number of them at the right price, when we have the ‘position of advantage‘.

    I would be pleased to discuss this information with you, however you would like to do that..


    Thanks for reading.


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