If Stocks Are Too High Why Didn’t They Crash by Now? Independent Financial Advice

Stocks have been high and rising for a several years. The current era reminds me of the ten year bubble in real estate and mortgages from 1997-2007 when the bubble seemed unstoppable and it seemed foolish to speak out against the bubble. Every year the bubble got more aggressive. The more that it expanded, the more the bearish critics of the bubble looked unwise. Overlapping this era was the 1997-2001 tech stock bubble. Investment advisors who advocated conservative fundamental analysis techniques instead of “momentum trading” or following the herd were left behind and discredited. But ultimately those who advocated fundamental traditional valuation metrics were vindicated.

   Never before has so much debt been used throughout the world at the same time. Previous economic cycles did not have so much stimulus and growth in Emerging Markets (including commodities) that were fueled by a huge debt bubble. Thus the experience of previous cycles will not be as relevant during this cycle. Emerging Markets may be coming out of period of excessive use of debt and may find that adding more debt won’t produce a reasonable return. The resulting reduction of global growth rates may harm the U.S. stock market. Half of the profits of U.S. companies come from Emerging Markets. Because EM countries don’t have the deep pockets and deep social safety net of Developed countries then when EM countries suffer from a downturn they will have less money for consumption and presumably won’t be able to contribute to the profits of U.S. stocks.

  An article in Barron’s on 8-5-2013 “Bracing for the Next U.S. Recession” quoted economist David Levy who said the economy can’t take the stress of higher interest rates and thus a recession may occur.

  Investors should be patient with holding a bearish portfolio and not be upset that stocks continue to go higher. The Small Cap index went up at a very fast pace in the past 12 months which implies either a massive business boom of stunning proportions will occur or else it is a bubble so be careful. The SP at 1700 today is still roughly 10% below its inflation adjusted high of 2000, so even now over a 13 year period it hasn’t beat bonds, even with a 2% dividend. Remember bonds paid roughly 6 to 4% for many of the past 13 years and produced capital gains until 12 months ago. From June 2000 to now $100 invested in Long Term Treasuries would be worth $243 today versus $129 for “Large Cap Blend” stocks, assuming compounding of dividends and interests by reinvestment was done in a tax deferred account with no commissions or fees. (This is simply the index return and not a return of an actual mutual fund)*. I admit part of the bond rally was a fluke caused by Federal Reserve manipulation, but the manipulation also helped stocks. Of course since bonds went up so much then it is best to assume they have reached their peak and may go down in value.

      I have written an article “GDP rise to end QE - Will stocks fall?”

      Investors should seek independent financial advice.

 

   *I used Morningstar “CAT” in mutual funds module and did 3 year rolling return 7-2000 to 7-2003 then 10 year from 7-2003 to 7-2013 and compounded the results.

About the author

Don Martin, CFP®

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