Welcome to the first “Market Musings,” a daily column which is intended to enlighten and entertain, with a sideways glance at markets in general. For those of you who are unfamiliar with me and my previous contributions to NASDAQ.com, let me start by introducing myself, before taking a look at the US stock market.
My love affair with markets began in my hometown of London, where I started a nearly twenty year career in the interbank Foreign Exchange market; a career that also took me to Tokyo, Moscow and Warsaw before I landed in the US. A short stint as a Financial Advisor with a major brokerage firm left me only too aware of the gap between retail investors’ perception of financial markets and the day to day reality of those on the inside; between Wall Street and Main Street, if you will. It is a desire to close that gap that drives what I write.
The Foreign Exchange market demands much if you are to be successful. You have to be able to shout very loud and wave your arms around with extreme vigor. You have to be familiar with, and know the correct usage of, every swear word known to man. More importantly, you have to understand that no market exists in a vacuum. It is becoming clichéd to say that we operate in a global economy, but it is still true. Even within national boundaries, the landscape has shifted. Markets that were the exclusive territory of Wall Street, such as futures, options and forex have become available on Main Street. For many people, it is no longer enough to simply buy and hold mutual funds and pay enormous fees to money managers; they want control over their own financial future. I hope to bring my experience on the inside of markets around the world to those people.
It seems appropriate that the first column should deal with the US stock market, and give an overview of the current situation. If the chatter at gatherings I attend is to be believed, that is what most people are concerned with right now. There is a strong sense of impending doom. It has, to this point, been a good year for stocks.
The S&P 500 index closed Friday at 1643.58, up just over 217 points or over 15% from its December 31st 2012 close of 1426.19. It is little wonder that people are getting nervous. If we have learnt one thing from the last twenty years, it is that the market cannot keep going up forever. There is a sense that a sickening decline must come soon. Every down day brings the feeling that this is the start of the big drop. The two key words here, however, are “sense” and “feeling”. Often a sense or feeling about the markets can be useful. It can, at least, prompt a review of the conventional wisdom with a cynical eye. That is never a bad thing. In this case, though, that review makes it hard to form a factual argument to support the feeling, largely due to one all important factor, the Federal Reserve Bank.
The S&P 500 is trading at a forward Price to Earnings Ratio (P/E) of just under 15. Assuming that neither the US nor global economy collapses, valuations look fair. If the rate of recovery continues its gradual increase, then there is still room for earnings expansion. Should economic data point to a weakening recovery, this will simply be taken by the market as evidence that QE will continue, and any drop in prices will likely be short-lived.
The feeling that the market is overbought, however, is not a function of P/E. It is more the sense that anybody who wants to buy is already in the market. If there are no buyers left, then the path of least resistance must be down. With a sustained rise such as we have seen this year, it is hard to escape that feeling. The continued presence of the Fed, though, changes the game here too. Even with Bernanke hinting at the dreaded “tapering”, or gradual reduction, of the bond buying program, the program is still in place. To those who feel that we may run out of buyers, I would point out that financial institutions are still being handed $85 Billion in new cash each month. That money has to go somewhere. China is slowing, increasing the perception of risk in Emerging Markets generally. Europe is still, quite frankly, a mess. Bonds are distinctly unattractive; with yields that are still low and that market would be affected directly were the Fed to reduce purchases. US stocks still look like the best of a bad bunch. Downward moves cannot be sustained with that much money chasing value in the market. The market’s role as a forward discounting mechanism is muted when any hint of a drop is immediately snuffed out by a flood of cash, so we have the ironic situation where the reaction to hints at the end of QE is overpowered by QE itself.
As I said, I have nothing against a “feeling” as the basis for a strategy. My FX background taught me that if everybody is long a market can only go down, regardless of any fundamental or technical analysis pointing to the contrary. In this case, however, the longs are being handed fresh bundles of cash with which to play every day. If your feeling is more based on the perception of a weak recovery, then I would maintain that it has never been anything else, but we are looking at stock indices up close to 150% since the depths of the recession. A slow recovery is still a recovery.
I am not denying that QE could, over time, prove to have long term undesirable effects. It is just that, for now, any fear that a crash is coming would seem to have little basis in fact. It would be easy for me, in the first of these columns, to confirm fears and talk of an imminent collapse. People love to have their bias confirmed, so it would make me popular, but it wouldn’t be an honest reading of the situation. For now, the old adage “Don’t fight the Fed” would seem to be the most apt advice.