After a dramatic week of a national US election, news from the FOMC, and somewhat positive data on the economy, the equity markets are back up to the April highs of the year. In order to fully understand the recent run-up in equity prices, we should look at the corresponding economic data points and market valuation indicators to determine if the market is poised for a correction or can we justify a continued sustainable rise in equity price through the end of the year.
First, consider the Conference Board's Index, "CEO's Confidence Survey". Back in April of this year the index was at 62, and the survey indicated that CEO's were becoming more confident in the outlook of business activity and believed future economic activity was improving. Though, they were still concerned with the uncertainty in the sales pipeline of their respective industries. In October the index dropped to 50 (any reading above 50 indicates more positive responses than negative). Below is a direct quote from the Conference Board's latest survey CEO survey results.
"CEOs’ appraisal of current economic conditions was much less favorable in the third quarter. Less than one-third say conditions have improved compared to six months ago, down from about two-thirds last quarter. In assessing their own industries, business leaders’ appraisal was also considerably less positive. Now, only 38 percent say conditions are better, compared with 61 percent last quarter.
CEOs are much more pessimistic about the short-term outlook. Only 22 percent of business leaders expect economic conditions to improve in the next six months, down from 48 percent last quarter. Expectations for their own industries are also downbeat, with about 28 percent of CEOs anticipating an improvement in the months ahead, down from 43 percent last quarter".
In the short-term, we are most concerned with the bullish sentiment within the current equity market. Currently, the NYSE High/Low index which measures investor's optimism is suggesting a potential market top. When the indicator is above 70% it demonstrates investors may becoming over-condident and it may be a time to take profits. A reading below 30% suggests investors are fearful and represent a good buying opportunity. Currently, the index reads 96, in which it has never been above 98. The last time this indicator was at 98 was May of 2010.
There is no doubt current equity valuations and investor's sentiment have soared since the recent market lows of late August. Shiller-PE ratios are almost 20% higher. The VIX, a measure of market volatility and fear, is at its lowest point since May. The ECRI leading index of economic activity stood at +12.5% in May now reads -6.5% (this index has improved from the August low reading of -10.2%). Lastly, the ISM Index of US manufacturing activity has drop 3.5 points from May's reading of 60.4 to 56.9. So, with the economy performing worse since the Spring, why is the stock market trading at 2010 highs.
The answer is simple.
investor's believe that the government and FOMC will do whatever it takes to artificially stimulate economic activity and growth, which may indeed stimulate growth. Just as the cash-for-clunkers artificially stimulated auto sales, and the new home purchase tax credit of $7,500 temporarily stimulated real estate activity.
Eventually, however, artificially induced markets usually revert back to their prior condition, and market speculators enter the scene. What we have seen in the recent past is this type of activity has not rejuvenated the consumer, which is why the economy continues to languish, and the real structural problems of the economy will continue to persist. Moreover, we continue to add more risk of rampant future inflation. Our hope is real sustainable job creation is just around the corner, which inevitably make the consumer feel more confident and the economic landscape will get back on stable footing. This in turn will discourage the Fed from its reckless course of action and create real organic economic activity.
Until this occurs, the stock market, bonds, and commodities will continue to be a speculator's game, and we will continue to buy insurance as protection of our assets.
