Markets at a Record High But These Aren’t Good Times

The US S&P 500 index took out two records Monday night Australia time.

The index traded at the highest ever level…and closed at the highest level ever too.

Good times.

Source: Bloomberg
Click to enlarge

But are these really ‘good times’?

As you know, we haven’t liked this market since the middle of last year.

We didn’t like it when it fell last August. We didn’t like it when it recovered in October. We didn’t like it when it fell in the new year.

And we haven’t liked it as the market has rebounded in recent weeks.

You know why already. But since when did the fear of repeating ourselves…erm…stop us from repeating ourselves?

The main reason we haven’t liked the market isn’t just because of everything that has happened over the past year.

We haven’t liked it because of everything that has happened since 2008.

US stocks aren’t trading at a record because the US economy is booming, or because it has recovered from the recession. The same goes for the Aussie market.

Stocks are going up for one reason — central bank money printing.

It’s important to remember that. It’s important to remember it, because it’s easy to forget it. It’s easy to forget what’s really powering this market rally…especially when most mainstream commentators believe it’s still a great time to buy stocks.

As Bloomberg reports:

Japanese shares drove gains in Asia, headed for their steepest two-day climb since February after Prime Minister Shinzo Abe said he’ll order a fresh fiscal stimulus package. Crude oil fell with sovereign bonds.

Fortunately, there is a sense of reality among some in the mainstream. The report continues:

“Strong U.S. momentum, the allure of continued low interest rates, some leadership certainty in the U.K. and a bold action plan in Japan is going head to head with caution following Brexit,” Cameron Bagrie, chief economist in Wellington at ANZ Bank New Zealand Ltd., said in a client note Tuesday. “The former held the upper hand overnight, and indeed a number of nights of late. Will it last? We suspect not. We don’t see why the latest package in Japan will work more miraculously than previous ones.”

We can’t help but agree.

Check out the chart below. In 2012, Japan promised to double the money supply. It sent stocks soaring:

Source: Bloomberg
Click to enlarge

But since that first rally ended in May 2013, the net return on Japanese stocks is close to zero.

And since the market peaked mid last year, the Nikkei 225 is actually down 22.8%.

The quick 1000-point rally in the Japanese index sure does look impressive on a super short term chart. It doesn’t look as impressive on the five-year chart we’ve shown above.

Of course, Japan has long since fallen into the trap of thinking that if a certain level of money printing isn’t working, the solution is to print some more.

And if a certain level of low interest rates isn’t working, take them lower.

It’s the economics of madmen.

Unfortunately, it’s a strategy the West’s central bankers are keen to try. The US Federal Reserve, with rates only barely above their record low, are now reluctant to increase them further.

Can it be much longer before the Fed creates another stimulus package? Sure, not while stocks are high. But when the market realises (as it has in Japan) that this strategy doesn’t work, it won’t be long before the Fed pulls out another of its tricks.

The Bank of England looks set to imitate the economics of madmen. As the Financial Times reports:

The Bank of England is set to cut interest rates to new historic lows on Thursday in an attempt to ease the pain of a predicted Brexit-induced economic slowdown.

The Bank of England’s benchmark interest rate is at 0.5%. The bond markets expect it to fall to 0.25% this week.

But heck, who cares? Stocks are high, so buy stocks. Let’s do a bit of self-fulfilling prophesying. But wait. Whenever you may feel the temptation to follow along with the unrealistic bull market, we like to pull a couple of charts out of the old kitbag.

For no other reason than to give you pause for thought…and to prevent you from doing something you may later regret.

First, for long-time readers, one of our favourites: This chart shows actual and forecast earnings for US stocks in the S&P 500 index:

Source: Bloomberg
Click to enlarge

The white line to the left of the green line shows actual company earnings. The white line to the right of the green line shows estimated company earnings.

In order for S&P 500 companies to achieve current earnings estimates, earnings will have to increase almost 16%.

Is that likely? Not in our view. If the US Federal Reserve was confident companies could achieve such earnings growth again, we’re pretty darn sure it wouldn’t keep interest rates at 0.5%.

And if folks want to argue that it’s the low interest rates that will deliver the 16% gain, we’ll ask why such a gain hasn’t been possible since 2010?

After all, interest rates were even lower during the previous six years.

This other chart is another favourite. It shows the Dow Jones Industrial Average (white line) and the Dow Jones Transportation Average (green line):

Source: Bloomberg
Click to enlarge

For the uninitiated, the premise of this chart relates to an analytical concept called the ‘Dow Theory’.

The theory (in basic terms) states that if industrial stocks are near a record high, transport stocks should be near record highs too.

That would provide a ‘confirmation’ that the market rally is genuine.

However, as you can see, while the Dow Industrial is only around 100 points from the record high, the Dow Transportation is more than 12% below the record high.

The divergence between industrial and transport stocks was one of the reasons why we issued a crash warning last year.

In our view, nothing has changed.

The Fed can hold off on a rate rise. The Bank of England can cut rates. The UK and Australia can confirm their respective Prime Ministers. But none of it matters a jot.

The current rally is a fools rally, and we wouldn’t have a bar of it.


Kris Sayce,
Publisher, Money Morning

Editor’s note: The above article is an edited extract from Port Phillip Insider.

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