Monday, 28 October 2013

With US stocks at fresh highs, will faith in Fed be tested?

Stocks in the United States rose last week, with the Standard & Poor’s 500 Index climbing 0.9 percent to close the week at a record high of 1,759.77. However, as the bull market continues, valuations for stocks have become stretched, leaving some analysts nervous.

Last week, Lance Roberts asked in a post at the Daily X-Change: Is a major correction coming?

He noted that currently, both the S&P 500 Index and the broad Wilshire 5000 Index have deviated from their long-term moving averages to extremes that have been seen only four times previously.

“The current deviation from the long term average, fueled by Federal Reserve interventions, is approaching extremes in both deviation and duration,” he wrote.

Roberts also cited a post by Cullen Roche at Pragmatic Capitalism last week. Roche wrote that “the market is just driving higher on what looks like sheer optimism of continued QE and little else”.

Roche cited two indicators of this optimism. One is stock market capitalisation as a percentage of gross national production, which is now at 110 percent, a reading that has “only been surpassed by the Nasdaq bubble”. The other indicator is margin debt at the New York Stock Exchange, which is now at an all-time high.

An article by Walter Hamilton and Andrew Tangel at the Los Angeles Times last week also mentioned the record level of margin debt.

The article also said that “optimism is everywhere”. It cited the latest weekly poll by the American Association of Individual Investors, where 49.2 percent of people responded by saying that they were bullish, up from 29 percent in late August, while bearish responses fell to 17.6 percent, the lowest since January 2012, from 43 percent.

Another recent survey by Barron's found that 65 percent of money managers were bullish while only 8 percent were bearish.

Again, it is all thanks to the Fed, apparently. The article quoted Patrick J. O'Hare, chief market analyst at, as saying: “Everyone is reading from same script — that you can't lose buying the dips because the Fed is by your side. And it's clearly working.”

Less confident in the Fed's ability to sustain the bull market in stocks is John Hussman. In an article last week entitled “Did Monetary Policy Cause the Recovery?”, he pointed out that aggressive monetary easing did not prevent the market from losing half of its value during the 2000-2002 and 2007-2009 plunges.

Indeed, Hussman asserts that monetary policy may not even have been the central factor in ending the banking crisis during the last recession. Instead, “the clearest and most immediate event that ended the banking crisis was not monetary policy, but the abandonment of mark-to-market accounting by the Financial Accounting Standards Board on March 16, 2009,” he wrote. That rule change “removed the risk of widespread bank insolvency by eliminating the need for banks to make their losses transparent”.

Hussman said that faith in the Fed's ability to sustain the current bull market “is already wavering, but the loss of this faith will be one of the most painful aspects of the completion of the present market cycle”.

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