Bulls are cheering the rise of the world’s best-known stock¬market index through the 13,000 mark. But the Dow Jones, now around 12% above its 2000 bubble peak, “signifies little or nothing”, says John Authers in the FT. It is calculated as a price-weighted index rather than in terms of market capitalisation like most other major indices. So stocks with the highest price (rather than those with the largest market value) have the most impact. Just four stocks account for 33% of the 1,000 points gained since October, notes Authers. A far more significant event would be the key S&P 500 index eclipsing its 2000 peak. It is just 2% away from this level.
Yet this is hardly a case of rational exuberance. It is “a strange environment for a rising stockmarket”, as John Mauldin says with masterful understatement on Investorsinsight.com. The fundamentals are lousy. The US economy grew at its weakest annual pace in four years – 1.3% – during the first quarter, according to a preliminary estimate, as the housing downturn gathered pace: home construction tumbled by an annual rate of 17%. The slump in the housing market, which had underpinned consumption, seems far from over given the steepest monthly fall in existing home sales for 18 years last month. Consumer spending rose at the slowest pace in five months in March.
Meanwhile, in February the Conference Board index of leading indicators turned negative, which in the past 40 years has foreshadowed a recession, says Edward Hadas on Breakingviews.com. It seems the stockmarket “is no longer a leading indicator but a lagging one”. It hardly helps matters that inflation according to the Fed’s preferred measure was up almost 0.5% to 2.2% in the first quarter, a problem that the weakening dollar – now back to a record low against the euro – could exacerbate by making imports more expensive and rate cuts even less likely. The weaker dollar has boosted earnings at US large caps and will help earnings grow by 7% this quarter. But while that’s better than the 3.5% initially pencilled in, the double-digit gains of the previous 14 quarters that investors have been used to are over, and the S&P’s p/e of 18 is still far above its historical average of 14.
Still, investors “don’t care” about the economy and profits, says Hadas: all they want is for buyouts and buybacks to keep buoying the market. These have taken around $1.1 trillion of shares out of the market over the past year, so investors are “dipping in a US equity pool that is nearly 5% smaller than a year ago”, says Francesco Guerrera in the FT. “A lot of money” is chasing lower supply.
Make that a vast amount of money. John Mauldin on Investorsinsight.com notes that money-supply indicators are rising “not only in the US but all over the world”. Record low interest rates in Europe and America, Asian trade surpluses and the explosive growth in derivatives has created a massive wave of liquidity to prop up markets. Indeed, absolutely everything is in bubble territory, according to veteran investor Jeremy Grantham.
When this unprecedented global bubble abates, all asset classes and countries are likely to be hit. But there’s no need to run for the hills just yet. Bubbles have a short but dramatic “exponential” phase (a final blow-off as prices rocket); witness Japan in 1989 or the dotcom boom in 2000. We have yet to reach this stage. It looks as though “pessimists and conservatives will take considerably more pain”.
But this will be nothing compared to the pain that investors – who have been whipped up into a greedy frenzy by hedge funds’ and private equity groups’ “often-borrowed” cash – will face when they wake up and find reality is “back with a vengeance”, says Alan Abelson in Barron’s. The economic backdrop invariably wins out in the end. This “overleveraged, overheated, overhyped market” will blow itself out… and “rock global bourses”.