Market Euphoria Is Where Things Stand

Share on FacebookTweet about this on TwitterShare on Google+Share on LinkedInEmail this to someonePrint this page

Market EuphoriaI don’t read charts. I can’t predict the short-term future any more than you. Yet at certain times, the market reaches a point where short-term direction seems obvious and easy to predict. The hard part is pinpointing the time.

So why try to time it perfectly. If you know it will happen eventually, plan for it now. It’s like filling sandbags after a flood, when the Weather Channel warned you for weeks.

I can’t predict the short-term any better than this: either the market continues this trek higher or it has a moment of clarity and relaxes until better information tells it where to go. For now, the signs seem to point higher with some concerns to consider.

What’s Working

My first thought is irrationality.

Then we saw the largest January inflows into equity funds in years. Did it extend into February? So far it has. And the money doesn’t seem to be coming from bond funds either. Rather, folks have sat on a lot of cash. Index funds have to put that money to work regardless of valuation. Fund managers might too. They can’t afford to miss a run and hope to keep their jobs at the end of year.

The Fed is still going full steam ahead. This pushes money into riskier equities to avoid the abysmal returns of bonds, CDs, and savings accounts. That 0.05% savings account rate doesn’t cut it. The fund flows finally seem to support that. Oh, it seems every other major monetary authority has jumped on board too.

Despite arguments to the contrary, the US is still the best place for long-term growth. Yes, there are other areas in the world to invest. International stock and bond funds continue to get a big chunk of money each month. Even so, U.S. stock funds saw the bulk of that money in January.

Fourth quarter earnings have been better than expected. You can easily say the bar was set too low. But revenues and earnings have been strong despite analyst predictive abilities. Companies are lean and the cash is flowing in.

The recent M&A deals are a good sign going forward. Companies are showing a willingness to spend…all…that…cash. A few took advantage of low borrowing rates. Which is what the Fed wants. I’ll say it now, it’s a good sign when companies don’t let their cash pile sit earning near nothing rates. This is a great sign for shareholders and for the economy. If this is the start to a bigger trend, watch out!

Concerns

When prices rise without any more catalysts to push higher, eventually demand wanes, prices level off and fall once sellers outnumber buyers. This happens everyday on a per stock basis. Collectively, this is reflected in the total market, the S&P 500, and finally, your index fund performance. This is a good thing, really. It’s a sign of a healthy market.

And its been almost 500 days since the US markets have had a 10% correction. Which is the 10th longest time in history without a pullback. Meaning, we’re due.

It’s been too quiet on the government front. Aside from the Presidents two speeches, we haven’t heard a peep since the fiscal cliff. That’s the benefit of a divided Congress, less meddling to worry about. Unless it’s important. Like the sequester? Those automatic spending cuts are set to start on March 1. And that mid March debt ceiling thing?

How will the market react when those discussions start making news? If it’s like the past two years…badly! The only difference this time around, as we saw with the fiscal cliff, we know Congress isn’t willing or dumb enough (I can’t always tell) to risk anything. So is the market not that concerned? After five years are we numb to these government failure to act threats and just assume it will get fixed?

There are still concerns in Europe. Though, not on the same level as the past few years. Several near term obstacles could get in the way and affect global markets. Which means uncertainty.

Market Cap to GNP Chart

Buffett’s favorite metric, the Total Market Cap to GNP ratio, rose above 100% this past week. It shows us where the market’s total value stands, under or overvalued, compared to the overall economy. Currently stock prices are slightly over valued.

If you look at the chart above, you can see what happens when the market rises well above GNP. The further Market Cap exceeds GNP, price risk rises, the number of value opportunities drop, and potential future returns drop significantly. A telling sign for those investors who buy the total market index funds. A something worth watching.

Lastly, delayed tax returns and a return to a normal payroll tax is affecting retail spending. This shouldn’t be a surprise really. Higher taxes, even if it’s 2%, is less money we have to spend. The late start to tax season hasn’t helped with needed tax refunds either. That’s what happens when tax codes are changed at the last-minute.

My thought is it’s time for a healthy correction. Just pick a reason above, if you need one. If those aren’t good enough, I like cash (now at 27% cash) waiting for an opportunity. And one’s overdue. Don’t take that to mean you should too. That’s what works for me. I’ll patiently sit and wait for the next opportunity.

Plan Of Action

Where do you go from here? There is a different answer for everyone. It boils down to your risk tolerance and time frame. A better question would be – where is the value?

The chance of finding value drops as prices rise. Stocks seem fairly priced. Bonds are overpriced. Both are risky. Chasing a second-rate investment with limited value and higher risk doesn’t make sense. Yet fund flows tend to say otherwise. You’ll have to decide how much risk you’re willing to take based on your time frame.

In the short-term, the market is an opportunity factory. High prices present selling opportunities. Take a look at those stocks or funds you’re just not comfortable holding for a long time. Those you own with the sole purpose of selling within a year. Why not look at selling, lock in your profits, and wait for a pullback or buying opportunity later? Or you can squeeze every last penny out of it. It’s your call.

Then there is everything else.

When you’re comfortable enough to own something for a long time why sell? That’s my view. It’s boring but it works. If you can time the peaks and troughs perfectly and exceed the extra costs, go for it. Everyone else should wait. Now is not the time to get crazy and deviate from your plan. Especially when value has deteriorated.

Most investors have money in some form of index or mutual fund. The chance of buying 500 undervalued stocks right now are low. With long-term investments, sometimes less is more. So?

Simply rebalance.

Anytime one market or another hits a short-term peak, it’s never a bad time to rebalance your portfolio to its preset allocation. By this I mean, if your original 60/40 stock to bond split moved to a 65/35 split with this stock run, sell 5% of your stock funds to buy bond funds to reset it. A more active investor might want to adjust it further. It’s an easy, low-cost way to buy low and sell high when your allocation grows out of whack.

Conclusion

Maybe I’m missing something or overly cautious, but it seems warranted. The economy is chugging along. There is a willingness to take more risks. Companies are spending again. Folks are investing again. Money is flowing into stocks. Everything is setting up for a long-term bull market. Yet, there is just enough areas of concern to be cautious. It’s a good time to hold long positions and see where the headlines take us.

Share on FacebookTweet about this on TwitterShare on Google+Share on LinkedInEmail this to someonePrint this page

Comments

  1. says

    Good points. I do get suspicious when everything seems so wonderful in the markets. Right now, my clients hold a 20% cash position. I expect to buy back into stocks when we hit that correction (perhaps the sequester will be the trigger). If not, I’ll be patient.

Leave a Reply