This week marked the third consecutive week that the stock market moved upward. A start reversal from January and in line with what I’ve been saying in my last two quarterly letters at my firm Bluemound Asset Management and my opening article of the year on MarketWatch – volatility will increase in 2015.
Interestingly, as the monthly swings have certainly become more apparent, the slow grind up, has masked that underlying volatility to many investors. The even deeper reality is that most investors are so oblivious to the risk they say they want to avoid, that they ignore what they can’t see.
As Rick has pointed out, the range of risks from a quantitative standpoint has clearly been rising for months. As I have pointed out, market value to GDP, as well as, Shillers CAPE ratio have reached the second highest points ever recently.
In Barron’s this weekend, they discussed in passing the the value of corporate equities vs GDP for the first time I’ve seen this year. That is a tell if ever there was one. Like a secret cable that disintegrates after reading it.
Folks, not only is the market overvalued, but it running on borrowed technical time as well. I can’t tell you how the series of events will play out precisely – nobody can – but I can break it down to a few scenarios that are likely:
- We get a small correction in the markets soon, which lets some air out of the bubble. That is followed by another leg up in the markets on some decent economic news. Ultimately, probably one to three years out, valuations get too high and global debt obligations overwhelm monetary stimulus causing the inevitable reversion to or below mean.
- We get a series of small corrections soon, which lets some air out of the bubble. That is followed by a flat choppy period in markets, on below expectation (wishful as it might be) economic data. Monetary stimulus in increased and global debts expand while deflation holds off an asset collapse for longer than three years.
- We get a sharp drop in markets, exceeding 30%, as without U.S. stimulus, there is simply not enough investor appetite for risky assets. That is followed by U.S. stimulus and we see a rebound rally. Ultimately, global debts become too burdensome and markets have a complete reset to below mean.
- The market zooms upward on irrational exuberance for a few more quarters, lifting the S&P 500 to over 2300, while global equity markets also rally. Ultimately, probably one to three years out, valuations get too high and global debt obligations overwhelm monetary stimulus causing the inevitable reversion below mean.
These aren’t the only scenarios of course, but they are the most likely in my opinion. I have listed them in order of what I think is likely. You’ll see that scenario one and two both are basically types of choppy markets with tremors before an earthquake. Rick and I talked about this in our last webcast.
Because every scenario shows that we are closing in on at least small corrections and eventually a crash, and that the time frame is narrowing every day, it is vital to remain liquid and flexible.
I am less than 75% long equities in every account and most are 25-50% long equities with the hedges that subscribers know about.
Here’s what I know. The financial industry wants you to be all in almost all the time. Why? Because they are selling something. Resist that sales pitch and propaganda. It’s bad for your financial health. Wait for the next real buying opportunity. Be patient. Go fishing, teach a kid to read, watch spring training baseball games, but don’t fret over your money being safe and earning little. You will get a “buy low” opportunity soon enough.