The bell that marks the top of the market

No one rings a bell at the top. Instead you have to figure out for yourself when it is time to sit out an overvalued market and wait for a better time to buy. That’s what every fund manager will tell you. But it isn’t 100% true.

In almost every collapse there is a bell of some kind. It’s just that most people are so caught up in the frenzy that they don’t hear it. That might be the case today.

You can read some of the story of the flotation of Chinese e-commerce giant Alibaba here. Some think its growth potential is such that a price/earnings ratio of 61 times offers good value. David Stockman (who we interviewed back in 2013) isn’t one of them.

According to the author of The Great Deformation: The Corruption of Capital in America, Alibaba doesn’t offer any hint of a sustainable business model to its bubble-drunk investors. Instead, it is “a purely derivative mass merchant of e-commerce… rolled into a convoluted financial pyramid that would have made Goldman Sachs’ ill-fated schemes of 1929 look reasonable”.

It has no “inventories, no stores, no warehouses, no patents, no state monopoly and virtually no fixed assets or working capital”. It just isn’t worth $230bn, or anything like it.

So why does anyone think it is? Why did Wall Street chuck so much money at an over-priced “mass merchant operating in a precarious economy”? Because “Wall Street is a momentum-driven casino that is now over-valuing everything that moves”.

This sounds like an extreme view. But almost every indicator you look at says something isn’t quite right in the US stockmarket. Tim Price, editor of The Price Report, referred to the market as a “tinderbox”.

We also looked at how the cyclically adjusted price/earnings (Cape) ratio, one of the few trustworthy valuation measures, is at historically high levels in the US, despite the fact that the market hasn’t even reached its previous inflation-adjusted peak yet. If history is any guide, that suggests miserable average stockmarket returns over the next decade.

I like Cape as a measure. But it isn’t much good as a short-term indicator. What worries me rather more in the immediate term is the tail-off in share buybacks.

We don’t approve of these at the best of times. But the key point is that companies themselves have been the biggest buyers of US equities for the last few years – quantitative easing has allowed them to borrow cheap money, which they have then used to buy their own shares and so push prices up.

That trend has come to an end: Andrew Lapthorne at Société Générale notes share buybacks fell by over 20% between the first and second quarters of 2014. Something else may keep the euphoria going – when central bankers are desperate, anything can happen.

We wouldn’t be surprised if, in a few years, we’ll be looking back and agreeing with Stockman that the listing of Alibaba was a clear sign that, in 2014, Wall Street is “off its rocker.”

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