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Your weekend reading:


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Here’s a little weekend reading while you watch the AT&T:

Investing, Markets

Investors Are Once Again Ignoring All The Red Flags And Setting Themselves Up For Failure

We’re currently witnessing an incredibly fascinating time in the financial markets. All kinds of people and media outlets are now talking about heightened risk in the stock market and I haven’t seen any real case made against it (just a LOT of logical fallacies). Still, investors keep pouring money in and the market keeps heading higher. It’s as if they’re laying down in front of a speeding locomotive, tying themselves to the tracks with their own greed.

Here are the 8 things we can all agree (based on their popularity in the press and lack of rebuttle) will doom investments made in the stock market today:

  1. Quantitative Easing is losing its efficacy and creating major imbalances. Ray Dalio recently argued that QE is now beginning to suffer from its own success in boosting asset prices. At the same time, the general public is realizing the whole program, by relying on the “wealth effect” to boost the economy, disproportionately benefits the rich while they see little or no benefit at all.
  2. But the Fed can’t stop or even taper QE without major repercussions in the financial markets. If QE’s greatest accomplishment has been boosting the economy via the wealth effect, it stands to reason that removing or even reducing it will have the opposite effect.
  3. Hence, the Fed is trapped. Richard Koo can’t find anyone to dispute this.
  4. Still, it can’t “print money” forever. At the current pace, the Fed is printing $1 trillion of new money every year and then spending much of that buying treasury bonds, essentially monetizing the debt. Even the Fed admits this cannot go on for long.
  5. Yet stocks are priced as though they will. Based on numerous metrics, including Warren Buffett’s favorite valuation metric, stocks are valued significantly higher than they have typically been in the past. In other words, very little risk is priced into the market at current levels.
  6. And investors are clearly optimistic about future returns. Why else would they pour record amounts of money into equity funds and use record amounts of leverage to boot?
  7. Even though they are guaranteed to be mediocre at best. Investment returns are based on the price you pay. Because prices are relatively high today future returns from current stock prices are reasonably estimated at 0-4% over the next decade.
  8. All of which means many investors are doomed to be let down. With potential “reward” in the low single digits and potential “risk” being 40-55% to the downside it seems investors have once again set themselves up for failure.

Isn’t it absolutely amazing how this happens time and time again?

Chart of the Day:

Oil has been a very good signal for stocks so far this year and it just took a pretty nasty tumble:


Charts, Investing, Markets

3 Reasons This Stock Market Is Eerily Reminiscent Of The Internet Bubble Years

art cashin“I do worry a little bit that we’re beginning to hear things that are reminiscent of the 1999-2000 period—the number of hits, the number of eyeballs. I think if we hold to the old tried-and-true—how many dollars are coming in—then we might be better served. But people are extrapolating, in some way, in a manner similar to the way they did in 1999-2000.” –Art Cashin

When I first read this it immediately reminded me of a study the Fed did on asset bubbles. It determined that bubbles are formed when investors, “extrapolate recent price action [or economic action] far into the future.” And I wouldn’t be surprised if Art was thinking of this when he used the term “extrapolating” in the quote above.

Over the past couple of weeks since he said it, I’ve noticed more than just a few facts that validate Art’s idea that the current stock market environment is eerily reminiscent of the 1999-2000 dot-com bubble. Here are three of them:

1) A prominent group of “sexy” companies has been rewarded/plagued with astronomical valuations. Last week I wrote a brief post about these momentum stocks and how investors ought to watch them for signs of broader market weakness because they typically lead in both directions. But let’s take a look at their current valuations.

Netflix trades at 270 times its trailing earnings; Facebook at 227x; LinkedIn at 850x; Pandora is N/A due to the fact that they have only reported losses (100x projected earnings for next year); Zillow is also N/A for the same reason (147x next year’s earnings); Tesla also has no earnings (94x next year); Yelp! is in the same boat (323x next year); and Priceline.com trades at a relatively cheap 35x.

Now I’m not saying any of these companies are the next Pets.com or even really making any kind of valuation call on any one of them but I don’t think we’ve seen these kinds of multiples since that former company was flying high on investor euphoria. But don’t take my word for it, the CEOs of Netflix and Tesla have recently lamented that their stock prices are way too high. Clearly, they remember what happened to companies that became the target of investor enthusiasm in the bubble years and don’t want any part of it.

2) Investors have become undeniably euphoric. So far this year investors have poured $277 billion in to stock funds, the most since 2000. This is another terrific example of how investors love to buy high and sell low. And while individual investors go gaga for stocks, Warren Buffett, just like he did in 2000, is sitting on a pile of cash practicing his famous maxim, ‘be fearful when others are greedy.’

Not only are investors putting cash to work in stocks at record highs in record amounts, they are going into debt to do so. Margin debt levels have recently hit levels only seen at major market peaks, including the 2000 stock market top.

Screen Shot 2013-10-21 at 2.07.51 PM

3) Technically (chartwise), stocks’ run from 2009 to 2013 is eerily reminiscent of the run from 1995 to 2000. The chart below comes from Todd Harrison:


What’s more:

Happy Halloween!

Economy, Investing, Markets

Why Ben Bernanke & Co Fear The Taper And Mr. Market Should Too

bernanke money printing

They’re printing money because they’re scared of what might happen if they don’t. –Albert Edwards

As you are probably already well aware, the Fed decided not to taper it’s $85 billion per month of bond purchases just yet. This threw most market watchers for a loop as Ben Bernanke had made it pretty clear leading up to the announcement that the Fed had every intention of beginning the process of removing this latest round of quantitative easing.

What I find interesting is that, as Stan Druckenmiller suggests, the Fed had primed the market for this tapering in bond purchases and essentially had a freebie to get it started yet they decided not to use it. Why?

Clearly, if the economy is not recovering like the Fed would hope then the $85 billion in money printing per month is just not working in the way that they hoped. The one way it has been effective is in boosting asset prices, making the rich richer but doing nothing for the unemployed. For this reason I asked on Twitter yesterday:

Minyanville’s Todd Harrison, who you can see in the new documentary about the Fed “Money For Nothing” (now in theaters), responded with a third reason and I totally agree. The Fed is now trapped. It’s printing $85 billion per month which is having very little if any positive effect on the economy yet it can’t stop without risking major repercussions.

As Stan Druckenmiller recently told Bloomberg:

If you didn’t believe before that the exit was gonna be tough, the mere hint that maybe in 3 months, if the economy’s good, we might go from 85 billion a month to buying 65 billion a month caused that kind of havoc and risk around the world how in the world does anybody think that when the actual exit actually happens prices are not gonna respond? It’s silly.

Ben Bernanke & Co. were clearly listening. Long-term interest rates nearly doubled on the mere mention of tapering while a few emerging markets saw their stock prices crash and foreign currencies went nuts. So the decision not to taper probably had less to do with the data and much to do with Fed officials fearing the ramifications of actually removing QE even to a small degree.


So we have a Fed fearful of what might happen to the markets and economy if QE is removed and, in stark contrast, investors celebrating the decision by pushing stock prices to new highs. If this isn’t the height of irony I don’t know what is.

At some point Mr. Market is going to realize that this isn’t at all bullish. In fact, the decision not to taper after laying all the groundwork may end up being an inflection point for investor confidence in the Fed. Fortune magazine ran an article earlier this week with the headline, “The Fed Has Lost All Credibility.” It concludes:

Lately it has been getting harder to believe Bernanke. He was continuing to say that the Fed won’t raise interest rates until mid-2015, yet by the Fed’s estimates and others, the unemployment rate by that point would be getting close to 6%, past where most people expect the Fed to raise interest rates. Wednesday’s taper two-step will diminish Bernanke and the Fed’s credibility further. The market went up today because it caught Bernanke in a lie. That will make it harder for Bernanke, and the Fed, to claim it really means it next time. So much for the power of communication.

I’ve been warning for months that when the Fed’s “confidence game” comes to an end it won’t be pretty for the markets. And the endgame may now be in sight.

Posts from earlier this week: