U.S. stock market's irrational exuberance

Don't cave to clients' demands to jump into equities and avoid cash

Apr 9, 2013 @ 12:01 am

By Dawn Bennett

The last time the Dow had 10 straight gains was in 1996 and it just achieved this again recently. Weeks prior to the last time in 1996, former Fed Chairman Alan Greenspan famously said the markets were possibly experiencing irrational exuberance.

Sixteen years later, here we are again and there is a similar type of irrational exuberance. Recently, when the Dow Jones hit a new record, he said irrational exuberance is the last term he would use to characterize what's going on in the financial markets and that the US stock market is undervalued because there are other factors compressing it.

This is the man I believe who singled-handedly created the housing bubble during his tenure. His statements beg the question, “Does he really know what he is talking about?”

Like Yogi Berra said, this is déjà vu all over again. Am I the only one who has a sense of been there, done that? This market is similar to last year when the markets had a run up on economic data around this time, only to flame out again. I believe this is another fake rise in the markets.

I am struggling to understand this new math such as GDP grinding down from 4.1% at the end of 2011 to .1% at the end of last year. How can this make the market run higher? What about across the board tax increases and $4 a gallon gas and the diminishing return of the monetary stimulus. How can these factors drive the market higher?

It's clear that any improvements are not durable. We need real employment to grow to make this market real. For all the hoopla, a dispassionate assessment of the data shows very little to be exuberant about. The country still counts 12.3 million unemployed compared to 7.2 million in 2007, meaning 77,000 people lost full time employment to no job or a part-time job. Did employers do that to avert Obamacare?

Whatever the reason, the upshot is still the same, more marginalized workers, less consumers. This is a consumer based economy and GDP. Less consumers, less GDP. This doesn't sound good or a reason to dump hard earned money into a US stock market that's running on fumes.

According to recent Factset data, of the corporate executives of 117 companies that offered guidance for next quarter, 82 have lowered earnings estimates, while only 25 have raised earnings guidance. Investors can't overlook the massive amount of insider trading that is going on, which is never a good sign as to what is about to come. Hard working Americans are being told to buy, buy, buy – that they are missing out – meanwhile insiders have been buying the least amount of shares this month. The ratio of insiders buying to selling is 50 to 1 according to Trimtabs. Bloomberg reports a 3 month average of insider selling of 12 to 1, which is a two year high. This is an ominous sign for the bull market camp.

There is cognitive dissonance as well when it comes to junk bond funds. There is the psychological dilemma because of a high desire for a higher yield, but that comes with rationalizing these bonds are safe. Investors are forgetting risk. Retired people are being forced into these investments because of a 0 interest rate environment. This is a common story and this asset class is beset by cognitive dissonance. Retired people should be concerned with protecting their principal, rather than hanging out their lives in speculative grade debt.

Some $820 million has found its way into these mutual funds the week ended March 6 according to Lipper. At the same time that institutions are short sellers of junk bond funds and short sales have reached cyclical highs. Big hedge funds – the smart money – are leading bets against junk. Big money is headed out the door.

Congress had delegated its duty and power over monetary policy to the Federal Reserve. Do they understand what they have done? Do they understand the economy? Markets are driven by fundamentals, which are not good, and people will get into trouble. Retail investors buy high and sell low. There is no logical math for the market run-up and there is irrational exuberance. Investors need to be careful. This market is frothy and we are in an unsecure economy.

Financial advisors are once again under pressure from their clients to jump back into lofty markets and shun cash at the wrong time. Don't cave to client emotions.

Dawn Bennett (atdbennett@bennettgroupfinancial.com) is co-portfolio manager of Bennett Funds and chief executive and founder of Bennett Group Financial Services.

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