Opinion: The U.S. stock market is 66% higher than it should be

Posted by jbrumley on July 12, 2017 2:49 PM
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The risks are piling up, but does anyone care?

By Thomas H. Kee Jr., MarketWatch

I have, in previous articles here on MarketWatch, pointed out the fundamental risks in the U.S. stock market.

I have identified the liquidity risks created by the European Central Bank and the Federal Reserve in the tightening of monetary policy, in the reduction of the Fed’s balance sheet, and the likelihood that these risks will prick the asset bubble that the market is in today.

Most people I speak and email with agree. The risks are high, as the price-to-earnings multiple of the S&P 500 (SPX) (about 25, depending on the indicator) is far greater than its historical norm (14.5). The truth, however, is that no one knows for sure. But, still, people are apathetic.

In fact, my experience over the past 20 years and through each of the past two major asset bubbles (the internet bubble in 2000 and the credit crisis in 2008-2009), is that the unanimous identification of an asset bubble did not take place until after the asset bubble had burst. By that time, all of the major indices — the Dow Jones Industrial Average (DJIA), S&P 500, Nasdaq 100 (NDX) and Russell 2000 (RUT) — had already fallen.

The result largely handcuffed investors to investments that were severely underwater. As luck would have it, though, after the credit crisis, the Fed’s policy-making body printed $2 trillion and, with that money, bought assets to prop up the economy and save investors from destruction.

Largely, this perceived savior is probably why investors are so lethargic when it comes to the asset bubble that we are probably in right now. This bubble even seems to include real estate and bonds in addition to stocks, and it has been driven by fabricated central bank liquidity.

Admittedly, I cannot be sure what will happen. I do not know if this bubble will burst, and I do not know if central banks will come running to the rescue again, as they did after the credit crisis. Unfortunately, I do know a great deal of people who believe that the central banks of the world will simply print more money if the going gets tough again, but that is a seriously risky bet.

With major indices coming off all-time highs and technical trading patterns (dojis) surfacing in long-term chart patterns last week, potential reversal signals are coming on a technical basis. As much as it is appealing to opt for relaxation and vacationing during the summer months, some time must be spent evaluating the conditions the market is facing right now.

In previous articles, I have offered alternatives to the traditional buy-and-hold methodology, and I think everyone should consider heading that way because strategies like “lock and walk” can work no matter what happens. The risks in the market today are extremely high for buy-and-hold investors because the liquidity picture is changing for the worse, and that is fundamental in nature. But longer-term technical observations point toward serious risks as well.

My longer-term macroeconomic analysis, The Investment Rate, is offering warnings that this market is 66% higher than it should be. Given the changes in liquidity and technical observations happening now, those risk warnings should be heard with an acute ear.

Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily. Kee managed the fourth-best-performing strategy in the world in 2016, according to HedgeCo.

From MarketWatch

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