Risk/Reward Vol. 196
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Baby you're a firework/Come on let your colors burst
Make 'em go "Oh, oh oh."
You're gunna leave 'em fallin' down-own-own."---lyrics from "Fireworks" sung by Katy Perry
"Cause he had high hopes/He had high hopes
He had high apple pie in the sky hopes."---lyrics from "High Hope" sung by Frank Sinatra
"One minute you laugh
The next minute you're slowly sinking into something black"--lyrics from "One Minute" sung by Kelly Clarkson
With the Dow Jones Industrial Average now above 16,000, many commentators question whether stocks are overpriced. Are equities like a "firework" with their "colors about to burst" from green to red? Will some event such as a tapering of the Federal Reserve's QE3 program "Make investors go 'Oh, oh oh", and "leave 'em fallin' down-own- own"? Someday likely, but many advise that that time has not yet arrived. Analysts such as Change Wave Investing's Josh Levine cite the price/earnings metrics devised by recent Nobel laureate Robert Shiller and conclude that although Shiller's adjusted S&P 500 p/e for this week is on the high side historically speaking (24.5 times compared to a 130 year average of 16.5x), it is significantly lower than during the dot.com bubble (44x) or in 2007 (28x). Levine counsels caution, but warns against panic, a sentiment shared by such luminaries as Mohammed El Erien and Jeremy Grantham.
A similar conclusion has been reached by Oaktree Capital Managment Chairman Howard Marks (a personal favorite, see Vol. 173 http://www.riskrewardblog.blogspot.com/ ) who looks to investor confidence for signals. It is his belief that when stock buyers have "high hopes/high apple pie in the sky hopes", prudent investors should be terrified, citing the dot.com bubble and 2007 as well. That said, he does not see the current bull market as motivated by overconfidence, but rather by low interest rates created by the monetary policies of the world's central banks (e.g. QE3). In the short run, he is steady-as-she-goes, counselling that when there is nothing clever to do, the mistake lies in trying to be clever. He advises caution; do nothing too drastic or too bold. And then there is another favorite of mine, David Tepper (Vols. 59 and 170 www.riskrewardblog.blogspot.com ) whose only fear is that he is not long enough in equities.
So we watch for signals. A favorite place for signals is found in the minutes of the Federal Reserve's Open Market Commitee, the entity that will decide the future of QE3. Many in the market live or die on them. "One minute they laugh/The next minute they sink" Talk about "sinking", look what happened on Wednesday. By mid morning the DJIA had once again crested above 16,000 and the 10 Year Treasury Bond yield was bobbing at 2.7%. With the afternoon release of the FOMC minutes, which were interpreted to mean that QE3 tapering could begin before an improvement in the unemployment numbers, the DJIA plummeted more than 100 points and the 10Year yield spiked to 2.8%. Quite a reaction to a few carefully chosen words! Can you imagine the upheavel if and when real action on QE3 is taken? Over the next two days, the stock indices recovered nicely, but the yield on the 10Year remained stubbornly high closing the week at 2.75%. This fact reinforced the wisdom of my decision to pare my interest rate sensitive holdings (e.g. mREIT's, BCC's and preferred stock closed end funds). Remember: when analyzing bond sensitive assets, the higher the yield the lower the price.
What's not to love about this market? Seven weeks---seven record closes! Like Ol' Blue Eyes, should we just continue "Taking A Chance On This Love" or is this a case in which "Fools Have Rushed In Where Wise Men Never Go"? It sure looks like we are on "The Sunny Side of the Street", but, Frank-ly, attaining record highs on lackluster economic news and lukewarm corporate guidance leaves me mostly "Bewitched, Bothered and Bewildered."
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