Credit: Shutterstock photoYesterday the S&P 500 closed at a record high, something that should make all of us with 401ks or other long term investment accounts feel all warm and fuzzy. The retirement investor in me does indeed feel that way, but the trader in me is getting increasingly nervous, based on what is happening in other markets.
For the stock market to be right and high multiples of forward earnings estimates to be justified, there has to be a pretty serious boost to growth in the near future. But both here in the U.S. and around the world, and other traditional indicators of global growth, such as bonds and commodities, are not giving that message. Could it be, though, that what we are witnessing is a breakdown in some of those traditional relationships?
The bond market, or rather the sovereign debt market that leads it, could easily be said to be in exceptional circumstances. It is easy now, nearly a decade on, to forget the nature and the severity of the recession from which we are still slowly recovering. It hit swift and hard, but was not just a run of the mill slowdown.
It was a credit crisis, where the markets that oil the squeaky wheels of commerce and industry dried up almost completely. Banks lost confidence in each other, let alone other borrowers. That is a rare thing, and when it has happened in the past, the subsequent recovery has been measured in decades rather than years.
In an attempt to accelerate that process, central banks embarked on a series of unusual policies. Interest rates at or near zero (ZIRP) was intended as a temporary measure, as was those central banks propping up the market for debt by buying it themselves, known as Quantitative Easing, or QE.
Seven years later, those policies are still in place around the world and have led to the price of that debt being at all time highs, thus leaving yields at all time lows. Normally, such high bond prices would signal a lack of confidence, a climate of fear even, and would presage a big drop in stocks. Yet here we are at record highs for the S&P, so evidently “normally” doesn’t apply here.
The other indicator of trouble ahead in conventional times is the market for commodities. The global nature of the market for things like copper and oil makes it a more general indicator of confidence in the economic outlook, and from that perspective too it is hard to justify stocks at these levels.
Both oil and copper have recovered from their extreme lows, but neither recovery has been exactly robust. Other indicators, such as the Baltic Dry Index are sending the same message. The index, which measures freight rates for shipping and is therefore considered a slightly forward indicator of global trade, has also recovered slightly over the last month or so, but is mired near 5 year lows.
What the bulls maintain is that, in these cases also, this time is different. The excessive run up in commodities that led to oil up over $100 in 2013 and 2014 was the result of the central bank policies mentioned above, they say. Free money had to go somewhere, and it went into commodities, causing a classic bubble. The high prices then encouraged increased production, which also sparked a big increase in shipping capacity, making the recovery after the bubble burst that much slower.
Basically the argument is that the current disconnect between stocks and other markets is as a result of those other markets being distorted, and the stock market is actually right. Given the history of the last 10 years that is a pretty convincing argument, but desk and floor traders are always taught that if markets are out of line, it is usually the stock market that is wrong.
Admittedly, that conventional wisdom comes mainly from arrogance; the reason usually given is that the public has more influence on stocks whereas things like Treasuries and commodities are controlled by the pros, and therefore cannot be wrong. It may be arrogant, but most of the time it is also correct.
You can see, then, why the trader in me remains nervous, but I keep coming back to two old market clichés.
The first is that you shouldn’t stand in front of a moving freight train. The market has enormous momentum right now, and that is a powerful thing.
The second is that the market can stay illogical a lot longer than you can stay solvent. It may be illogical for stocks to hit highs when bonds are doing the same and when commodities are weak. But we are all making money, so who cares?
I do. I am quite prepared to ride the wave for now, but I will do so with a wary eye and ready to turn on a dime if the traditional indicators do turn out to be right.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
