Since
Trump’s election, the US stock market has climbed unstoppably
along a remarkably steep path to round off at a teetering height.
Is this the
irrational exuberance that typically marks the last
push before a perilous plunge, or is the market reaching escape
velocity from the relentless gravity of the Great Recession?
This burst of enthusiasm in response to Trump’s victory, flew in the
face of almost everyone’s predictions. That it lifted
the market from seven months of languor certainly makes 20K on the Dow
look like the elevation marker of a breathtaking summit.
While breaking 20k, if it happens, may be as meaningless as one more
mile on the odometer when all the numbers roll over, it is
psychologically potent for many. Breaking through it, could cause fear
as eyes turn down and see how far below the earth now is, or the
rarified air up here may bring euphoria that lifts the market to even
greater levels on a rising current of hot air.
Investors have been buying and selling with as much frenzy as
Christmas shoppers. Now there will be much eating and drinking to
celebrate this record-setting Santa-Clause rally, even if it doesn’t top
20, before Christmas, as investors take a brief rest to enjoy their
surprise gains, fat and happy in belief that 2017 will be a prosperous
new year.
There is almost no evidence of fear amongst all the cheer. According
to Gallop, economic confidence has never been higher in the general
population. Some are calling it
Trumphoria as
people seem to be relieved that eight years of Obamanomics are ending,
and business is seizing the reins of government, guided by one of the
world’s richest and most dazzling developers.
The first positive double-digit index score since the inception of
Gallup Daily tracking in 2008 reflects a stark change in Americans’
confidence in the U.S. economy from the negative views they expressed in
most weeks over the past nine years.
A similar CNBC survey indicates this is the greatest breath of fresh
air for consumer confidence since Obama was elected in 2008, and it is
not just stocks that are soaring. The US dollar has reached its highest
peak in fourteen years.
TechonoMetrica also says consumer confidence has just hit its highest level since 2006 (just in time for Christmas shopping).
The surge in consumer confidence is primarily due to a collective
sense of relief among Americans over the conclusion of the contentious
2016 presidential election season, as well as a feeling of hope
regarding the prospect of a new administration taking office…. Consumers
are ecstatic that the election is finally over.
Will this exuberant ride continue in 2017?
Many analysts believe the push through a major milestone, if it
happens, confirms a strong new market trend; but what does history say
about breaking past such major psychological resistance barriers? When
the Dow first broke past the 100 level in 1916, it tumbled below the
line immediately and then sputtered along that ceiling for almost ten
years. It didn’t break through with any continuance again until the mid
20s! When the Dow flirted with the 1,000 mark for the first time in
1966, it tumbled down and again stumbled along near that ceiling
for seven years. When it finally passed it at the end of 1972, it did
continue a tiny ways higher; but in less than three months the market
fell for the next two years, eventually plumbing a depth 44% lower,
while the nation sank into recession. The Dow didn’t permanently break
through 1,000 again until 1982! And, after the Dow broke major, major
milestone of 10,000 in 1999, it made it about 10% above that and then
fell about 30% from 2001 to 2003 in what became known as the dot-com
crash.
What if we look at what history has to say about irrational
exuberance by using other measures than the Dow? The ratio of stock
prices against corporate earnings is one of the most common ways of
assessing the relative height of a market peak. Here again, there are
only a few times in history that the S&P 500 has climbed to prices
that are 27.9 times more than corporate earnings of the last ten years,
which is where the S&P stands now. Once was in 1929 just before the
Great Depression, then again in an ill-fated boom of the 60’s, and only
one other time in 2002.
The altimeter I’m using here to assess our present peak is called the
CAPE (the Cyclically Adjusted Price-Earnings ratio that won Yale’s
Robert Schiller his Nobel Prize). In market terms, our present mark
on the gauge means we’re entering the stratosphere! Even in 2007, the
market was not this overpriced by the CAPE’s measure, and irrational
exuberance has always accompanied this level: (Some will argue
otherwise, but hang with me a minute.)
Early 1929 was actually a fantastic time to get into the US stock
market — so long as you didn’t stick around. So were the late 1990s.
Someone who sold their stocks in late 1996, when the CAPE hit 28, missed
out on the biggest free-money bubble bonanza in recorded
history…. Nonetheless … over the past 150 years, it has generally been
an extremely poor move to invest in U.S. stocks with the CAPE at these
levels. (Market watch)
Not everyone thinks passing this mark on the CAPE matters. In fact,
apparently many don’t, or the stock market wouldn’t have kept climbing
into the CAPE’s red zone this month, but according to Valentin Dimitrov
of Rutgers University and Prem Jain of Georgetown, the measure has been
applied too simplistically by those who disregard it:
In a nutshell: Investors shouldn’t flee stocks simply because the
Shiller PE is above average. They shouldn’t flee stocks even when the
Shiller PE is way above average. But history has said they
should flee stocks when the Shiller PE is at extreme levels — like
now. Only when the CAPE is “higher than 27.6”, they conclude, has the
stock market proven to be a really bad investment. (Marketwatch)
It is, however, not just the height of this peak, but the rate of
rise that evidences irrational exuberance. This month, the US stock
roller coaster ratcheted its way relentlessly up its highest hill one
clanky link at a time. If the Dow closes above 20,000 this week, it will
be the fastest 1,000-point rise in market history! The previous record
rate of rise came in 1999 in the run-up to the dot-com bubble crash. Of
course, the higher the market is, the less meaningful a thousand-point
rise is.
Do these graphs look like irrational exuberance?
Sometimes a visual says more than words:
Fastest, longest rise of the Dow in the past two years. Irrational exuberance?
Notice that it is not just prices that have shot up. Sometimes prices
soar while trading volume treads flatly. In other words, there are very
few traders, but those that are buying are willing to pay more. This
time, trading volume has gone astronomical (lower part of graph) as
money floods into stocks. That means it’s a flurry of high-stakes
trading. The last time we saw this kind of trading volume was …
Is the steepest climb in a decade irrational
exuberance, particularly when accompanied by the highest trading volume
since the Great Recession began?
Yes, the last time trading volume (lower graph) reached this
frenzy was in 2008 and 2009 when we experienced the greatest stock
market crash since the Great Depression. And look how long and steep the
post-Trump rally (right end of upper graph) looks compared to any other
climb during the past
decade, including the run-up to the Great Recession. It’s almost a straight-up wall!
How irrationally exuberant are investors right now?
Forget about measures for a moment, let’s look at forecasts by the
revered experts in the industry because if everyone is running with glee
in the same direction …
Some market experts are espousing an unequivocally bullish outlook
for equities. That level of enthusiasm was on full display after Robert
Doll, Nuveen Asset Management’s chief equity strategist, on Wednesday
said he was “fully invested” in the market. Asked by one CNBC reporter
if he recommended keeping any cash holdings … Doll had this to say: Hold
cash? “What for? Market’s going up!” (Marketwatch)
Clearly, Doll sees no top to the hill in sight. Apparently neither do
others: in spite of our present nose-bleed heights, Wall Street’s gauge
of investor fear, the CBOE Volatility Index VIX, rests comfortably at a
16-month low. Seems almost no one sees any reason for concern at all.
Lance Roberts writes,
Over this past weekend, Barron’s Magazine published its big story the “2017 Market Outlook….” After 8-years of a bull market advance not one of the forecasters had a “bearish” outlook. In fact, as the article concludes: “If all goes smoothly, our experts’ forecasts might even prove too tepid.
The old bull isn’t ready to call it quits yet….” Of course, since it is
rising asset prices which drives their business – being “bullish” is
good for business…. However … it is extremes in both “psychology” and
“behaviors” that tend to give us the best indications as to future
outcomes. The legendary Bob Farrell had two rules specifically relating
to today’s topic. The first was … “When all the experts and forecasts agree – something else is going to happen.”
Barron’s panel of ten experts (from JPMorgan, Goldman Sachs,
Barclays, Citi, Morgan Stanley, BofA, Blackrock and others)
were unanimous in their cheer that the US stock market will ascend well
beyond its present record heights.
But, if everything is so rosy,
Wolf Richter
asks, why are bank insiders and big industrials selling their own
company’s stocks faster than ever: (Someone has to be selling for all
that buying to happen.)
Why are insiders at banks and industrial companies selling their shares as if there were no tomorrow? Banks
had a blistering run. The shares of Wells Fargo, the most hated bank in
America these days, soared 28% over the past 30 days, Citigroup 25%, JP
Morgan 26%, Goldman Sachs, which is successfully placing its people
inside the Trump administration, 37%. It has surged 50% since the end of
October…. But high-ranking insiders have been dumping their
shares faster than at any time in the data going back to 2003. These
executives are considered the “smart money.”
Have market insiders just lost their appetite for dizzying heights,
or do they have reason to believe they are selling into the stock
market’s last hurrah? Are their banks, perhaps, getting clobbered by the
bond crisis that is now developing on the other side of all this
trading?
Even the
Wall Street Journal, notes Richter, saw this high-volume trading as a bullish sign. They couldn’t, however, say
why
it was bullish, but only that it might be profit-taking. Well, why take
profits now if you’re confident your bank has room to run? Is
WSJ’s bullish note just more irrational exuberance from all market experts who can smell nothing but roses since Trump’s victory?
This is how BofA’s Michael Hartnett explains it: Wall St. is bullish:
expectations of “above trend” growth at five-year highs … global
inflation expectations at second highest % since Jun 2004 … global bank
stock positioning has hit record highs. (Zero Hedge)
Bonds are smarter … and far from exuberant
One old adage says that bond traders are the smart money. Money is
now fleeing bonds at a record rate of fall that matches the record rate
of rise we are seeing in the stock market. Bond money has to go
somewhere; so, it could easily be that stocks are going up less because
of Trumphoria and more because of bond phobia, triggered by Trump. Fear
of what could easily turn into the biggest bond-bubble crash in the
history of the world makes stocks look like the safest haven.
The global realization that central banks are not so enthusiastic
about additional stimulus anymore, has bond investor’s realizing that
the longest bull market in bond history may finally be waning. At the
same time Trump’s plan of spending somewhere between half a trillion and
one trillion dollars on infrastructure investments (financed on
national credit) means interest rates will have to rise in order to
attract enough creditors, which they are already doing in
anticipation. In many nations, investors’ money is trapped in bonds near
zero-percent interest. Knowing higher interest on new bonds is almost
inevitable now, these investors want to get their money out of current
bonds. Even in the US, who wants to be stuck in bonds at 2.5% for ten
years when two to three years from now, interest may be at 5%?
The prevalent thinking is that Trump’s credit-card spending spree
will heat the economy with numerous new jobs, and those new jobs
will raise wages in order to attract enough workers. The increased
demand for great amounts of materials will also drive up the cost of
materials for everyone. The combination of many more workers flush with
new cash and rising demand for materials means inflation will rise
significantly; and inflation eats away at the value of money stored in
bonds. So, one more reason to exit bonds. Goldman Sachs believes the
main effect from fiscal stimulus this late in the employment recovery
curve will be to drive up interest and inflation.
In my view, all of that means the Fed’s statement that it will be
raising interest more often next year is now irrelevant. I said that
before the Fed’s last meeting, and I think we see it is true in the
stock market’s relative indifference to what the Fed said. Interest
rates are already rising everywhere in the US economy, regardless of the
Fed’s target. So, the Fed is clearly failing to accomplish anything
with its stated target rate because the market is finally taking over
and driving interest. That is why it was easy for the Fed to say it will
increase its number of rate increases. I suspect its stated target will
play catchup all year in 2017 to what the market is already doing with
interest rates.
So the bond bull is breaking; but that break can cause major bond
funds to wind up in liquidity traps where they cannot pay off investors
who want out fast enough because the more they sell bonds that people
don’t want anyway to raise cash and pay out investors, the more they
have to lower the price to make a sale, driving down the value of the
bonds they continue to hold, causing more investors to want out. The
breaking of the longest and highest bond bull market in history could
become a financial vortex, and bond values have already been falling at
their fastest rate in history.
David Gundlach, the bond king who manages the DoubleLine Total Return
Bond Fund, sees trouble if bonds get about half a percent higher than
they are today:
We’re getting to the point where further rises in Treasurys,
certainly above 3 percent, would start to have a real impact on market
liquidity in corporate bonds and junk bonds…. Also, a 10-year Treasury
above 3 percent in my view starts to bring into question some of the
aspects of the stock market and of the housing market in particular. (Newsmax)
If bond funds go bust, they will likely take banks and retirement
funds and ultimately the whole economy down with them, since almost
everyone has been parking large amounts of money in bond funds because
they are typically viewed as safe havens in uncertain times. If all of
that goes down, the stock market likely does, too. It’s hard to see how
it wouldn’t. It’s always been hard for me to see which would go first in
the next big drop back into the Great Recession because both look so
dangerous, and it is still hard to say. Will the insolvency of bond
funds wipe out some banks and hedge fund managers, taking their stocks
down to nothing, or will irrational exuberance in the stock market give
way to panic? Right now, it appears to me that bonds will lead the
crash.
Of course, I predicted the
Epocalypse of
2016, so you might not want to listen to me. (Though I did say it might
not happen until after the election when the Fed gives up and lets
Trump take the fall.) I also predicted a second plunge in the price of
oil in 2016, and that didn’t happen either. My predictions for 2016 were
apparently badly off (at least in timing) for the first time in almost a
decade. I started writing regularly on eonomics after predicting the
crash of the housing market nearly to the month back in 2007, which I
said would quickly become an enduring global catastrophe, the likes of
which few people alive had ever seen.
That said, I anticipate the remainder of this December will go
something like last year’s transition into the new year where the market
crashed in the manner I said it would by going up first (due to
euphoria that the Fed’s interest rate increase didn’t bring down the
house), then rounds off and then falls off a cliff; but we’ll see. I’m
not certain of that this year, as I was last year, and the fall off the
cliff last year was not as severe as I thought it would be … though it
was the worst January in the history of the stock market. This year, the
euphoria is MUCH higher, so the fall could be much greater and be the
kind that I anticipated for 2016.
Is it irrational for stocks to rise due to betting on the Trump card?
It could be. Consider that the entire marketplace began shifting
overnight out of bonds and into stocks when Trump won, and it’s still
shifting like a huge landslide. What if it repositions to this large
degree, and then Trump changes his positions … again? As a matter
of fact, he’s already started to backpedal from his infrastructure
pledge just as he has been doing from almost all of his stated campaign
pledges since being elected:
Trump made rebuilding the nation’s aging roads, bridges and airports
very much part of his job-creation strategy in the presidential race.
But lately lobbyists have begun to fear that there won’t be an infrastructure proposal at all, or at least not the grand plan they’d been led to expect…. Senate
Majority Leader Mitch McConnell tried to tamp down expectations last
week, telling reporters he wants to avoid “a $1 trillion stimulus.”
And Reince Priebus, who will be Trump’s chief of staff, said in a radio
interview that the new administration will focus in its first nine
months with other issues… He sidestepped questions about the
infrastructure plan. In a post-election interview with The New York Times, Trump
himself seemed to back away, saying infrastructure won’t be a “core”
part of the first few years of his administration…. He acknowledged that
he didn’t realize during the campaign that New Deal-style proposals to
put people to work building infrastructure might conflict with his
party’s small-government philosophy. “That’s not a very Republican thing
— I didn’t even know that, frankly,” he said. (Newsmax)
Seriously? Wow! How could he not know this, given that Republicans
have resisted doing any infrastructure stimulus plans for eight years?
He is either
scarily out of touch if he didn’t realize he’d have a fight from the Republican congress, or this statement is proof that
Trump was a Trojan horse
from the beginning. This is a remarkably rapid turn from the
New-Big-Deal plan that Steve Bannon advocated as being the economy’s
salvation, given that Trump is not even in office yet.
We could have one wild roller coaster ride in 2017 since the market
is entirely repositioning itself toward Trump’s infrastructure pledge
if that plan takes a few years to come about or doesn’t make it through
congress at all … or maybe doesn’t even get presented. It certainly
never had a chance of making it through congress unless Trump pushed
hard and leveraged his campaign victory toward that end, and the above
statements don’t sound like Trump has any push left!
Zero Hedge recently reported on growing Republican resistance to Trump’s tax and infrastructure plans:
[In an article titled] “A “Big Problem” Emerges For Trump’s Economic
Plan” … we reported that while the market may (still) be blissfully
unaware about the emerging conflict between Trump’s debt-fueled vision
for the future, Republican politicians had started to
notice…. Republican lawmakers warned “that there could be a major
obstacle to enacting President-elect Donald Trump’s agenda: the national
debt.” “I was disappointed that it wasn’t brought up in the campaign,…”
Sen. Jeff Flake (R-Ariz.) said of deficits and debt. “So I’m very
concerned about it. It’s going to be tough to address if there’s no push
from outside of the Congress,” he added. “I’m very concerned about it.
It’s the biggest problem we face, by far.”
Rapidly rising interest rates already mean the infrastructure program
will become much harder to finance. If Trump waits three years to get
seriously started, interest rates could make the plan nearly impossible,
plus he will likely have expended all his political capital that comes
from a surprise election victory, which will be ancient news by then. He
will need that capital to get the plan through a reluctant congress.
Rising interest rates already mean the mammoth national debt that
came about as the result of the Great Recession will become much harder
to finance over the next few years, even without taking out another
trillion for new infrastructure. So, that will be a new and serious
burden on the economy unless so much money flees Europe to bond and
stock safety in the US that we’re saved by dumb luck … as once again
being the best horse in the glue factory.
So, is the stock market irrational in its exuberance for shifting so
much just because of Trump’s pledges, which are far, far from
becoming reality? I think so. I haven’t even talked about Democrat
resistance to Trump’s plans, and he’s already got resistance from the
Republican leader of the senate. He is already fading back on his own
push for the plan … before he is even in office. He has faded back on
almost everything he has promised.
So, I think it is extremely irrational for the market to completely
reposition from bonds to stocks — especially banking stocks — when Trump
is hedging his words on all of his pledges … backpedaling hard on
immigration enforcement and on putting Hillary in jail and now even on
infrastructure spending.
David Rosenberg, chief investment strategist at Gluskin Sheff & Associates Inc., agrees:
The bullish run “probably can get extended into the new year,” but
“we’ve just taken a very big leg up here, and levels of sentiment,
levels of market positioning and levels of valuation do have me a bit
worried that if we see any disappointment at all, it could lead to the
sort of pullback we had last year….” Rosenberg calls current valuation
levels “extreme.” (Newsmax)
Gathering around the stock ticker in the US stock market crash of 1929.
That doesn’t mean the market won’t keep going up. Who knows what the
maximum height or duration of irrational exuberance is (because who
knows how crazy people can get); but I am certain of this much: the
higher stock market rockets upward on such irrationality, the harder it
falls into the chasm of ever-growing debt from which it has been
constructed. NO significant economic reforms have happened since the
start of the Great Recession. There has been no significant improvement
in corporate earnings, just a lot of expanded debt to buy back shares in
order to improve Price-Earning ratios, which still look terrible. The
entire market is but a poof of speculative hot air.
But, for the time being, Merry Christmas. If you’re not heavily
invested in stocks or bonds, raise a glass of cheer and party on because
you have less to fear. There is nothing you’re going to do that can
stop the markets (in stocks and bonds) from having their hangover when
the bubbly stuff is over and irrational exuberance suddenly looks like
delirium. Our greatest economic crashes have always happened when least
expected.
—David Haggith
