News & Insights
Let’s Do That Again!
The year 2013 was wonderful for stocks with all of the major U.S. stock indices ending up the year substantially higher than where they stood at the end of 2012. Our position as we entered 2013 was that the stock market was fully valued on a fundamental basis. But we noted if past was prologue, the market would continue to rise on the back of Federal Reserve policy, improving sentiment and better economics. During this overvalued phase of the current cyclical bull market,we ventured that the market could rise another 15% to 30% as reluctant and late investors joined the party. Even though earnings on the S&P 500 grew only 6% in 2013, the index surged in price over 30%, indicating investors’ willingness to pay substantially more for a dollar’s worth of earnings than before.
The stock market has arrived at a lofty place and since we have just popped the champagne to usher in the New Year, it is appropriate to ask whether or not we are in a stock market bubble. Supporting this notion are several factors when taken together tell a story that raises concerns. Margin debt, when people borrow money to buy stocks, is higher now than just before the market crash in 2008. The cyclically adjusted price earnings ratio of the S&P 500 now rests above 25 compared to an historical average of around 18. Respected individual and institutional investor sentiment surveys show that Bulls far outnumber Bears as we enter the New Year. This is usually a contrary indicator; when most investors are “bullish” a correction is often in the cards.
None of these factors by themselves are enough to cause alarm. Even taken together they do not form the discernable outlines of a real bubble a la 2000 or 2007. However, we do think they are cause to continue a mildly defensive stance towards the market in 2014.
Even though the valuation metrics support the idea of a falling or stalled market, it is difficult to see what might cause the market to dramatically reverse course. The Fed, even though it has begun its “taper,” has strongly indicated its intent to stay on the side of investors. The Bank of Japan and the European Central Bank have joined the Fed, making its reflationary policy a global phenomenon. Leading economic indicators have continued to improve heralding stronger economic growth.
While a bubble may be forming, it is likely to continue to inflate until concerns of an overheating economy and inflation force central bankers to abandon supportive monetary policy. Even though we think there is a better than even chance of the stock market’s continued rise in 2014, we will maintain a conservative position in recognition of the higher risks inferred by richer stock prices in the U.S.
The Altavista Investment Team - Winter 2014