My Two Cents - "Irrational Exuberance - Part II"

5/10/2013

Every so often the mainstream does get it right; they just don’t realize it. Or maybe they do. There is an old saying that every lie has 90% truth otherwise nobody would believe it. The hysteria over the Dow’s recent punch through the 15,000 level has everyone associated with stocks almost giddy. Or maybe totally giddy. Or maybe totally disconnected from reality. Take your pick.

The article I’m going to dissect can be found easily by a quick search, but it really doesn’t matter who wrote it or where it was published. What matters is the content and the rationalizing that takes place. That alone is worthy of analysis and commentary. Before we get started, I will go on the record as not really caring about Dow 15,000. Having been in this industry for quite a few years now and an investor for nearly 20 years, I understand the irrelevance of ‘indexes’. Sure, if we buy some index ETFs, etc., we can ‘make money’. But are we really investing? Let’s take this article apart and you’ll get a pretty good idea of where most folks are coming from these days.

“The Dow Jones Industrial Average closed above 15000 for the first time Tuesday as stocks continue a historic four-year run that investors are finding increasingly irresistible.

The Dow is off to its fastest start to any year since the dot-com-fueled bull market of 1999. But this time around the surge isn't driven by blind optimism—many investors simply see few alternatives to stocks.”

Not driven by blind optimism? Notice the direct contradiction between the first and second paragraphs. ‘Investors are finding increasingly irresistible’ vs. ‘the surge isn’t driven by blind optimism.’ First we must question who these ‘investors’ are. I’ll say the same thing I said back in 2009 when this rally was kicked off: This is not Ma and Pa Main Street digging for quarters in the sofa to buy stocks. This is mostly large institutions, banks, and hedge funds dumping the money the not-so-USFed continues to pump into their coffers in exchange for illiquid mortgage bonds and other junk assets.

Quantitative Easing is the Air in the Bubble

They call it quantitative easing. Bubbles Bernanke missed the housing bubble his institution helped to pump up and of course he’s missing this one too. The big lie about QE was that it was going to help the economy. I’ll say this loudly one final time: The stock market IS NOT the economy. How does giving a bunch of banks a trainload of cash for their worthless ‘assets’ help the economy anyway? All this type of activity does is create more bubbles. The not-so-USFed loves QE though, because it helps them direct where the money goes. A good portion of that money has been used to short gold and silver and bolster confidence in the dollar. Some has been used to purchase USGovt debt. Some has gone into the equity markets. With wages stagnant and the cost of living increasing it is reasonable to make the assertion that this massive stock market rally isn’t being spearheaded by a healed and suddenly re-energized American taxpayer.

I’ll add a bit of history here. The small investor nearly always does the exact opposite of what they should be doing. They buy the tops and sell the bottoms. We can see more and more of this mentality at work as people who have little to nothing in the way of investable assets are beginning to clamor to get a piece of the big rally. As they article said, people are finding it irresistible.

Traders say the stock market's march into record territory has been fed by a steady stream of buying. That includes smaller investors who had for the most part shunned U.S. stocks in the years since the financial crisis.

"This has been a pretty resilient market," said Sean Lynch, global investment strategist at Wells Fargo Private Bank, which oversees about $170 billion in assets. "Investors have played the worry game, and those that have sat on the sidelines in cash are starting to question that."

I guess the point of Mr. Lynch’s comments is that we shouldn’t worry about Europe in recession, China sputtering, and a homeland economy that requires steady and massive infusions of debt-sourced government spending to keep the wheels from falling off. The truth is we’re desensitized to crisis simply because there have been so many. People have already forgotten 2008 and they’ve forgotten the markets amazing volatility while Congress fiddled with the debt ceiling back in July of 2011. The rally marched on through it all, fueled by every-increasing amounts of QE cash.
In Q1’s edition of the firm’s newsletter I wrote about the wealth effect and how critical it is to propping up the USEconomy. A rising stock market and sound bytes such as are highlighted in this article are necessary contributing factors to the wealth effect. The government and banking sector are also doing anything and everything to re-inflate the real estate bubble. We’re back to the land of zero-down mortgages again. Rates are at historic lows thanks to monetary malfeasance. Anything to keep the spending (and more importantly) the accumulation of debt going. And in typical Euroland fashion, we’re more than happy to accommodate.

Fueling the growing confidence in stocks is a sense that the U.S. economy is healthy enough that recession isn't a concern but not so strong that the Federal Reserve will pull back on its aggressive measures to ease monetary policy.

The Fed's efforts to keep interest rates extremely low are seen by many as a key driver of the rally.

In recent months, the blue-chip Dow has seemed particularly impervious to economic and political headwinds. The Dow is already up 15% this year, despite a congressional battle over the federal deficit and a banking crisis in Cyprus that threatened a flare-up in the euro zone's continuing debt woes.

The USEconomy is healthy enough that recession isn’t a concern? Hey Slick, how about we pull out the trillion bucks and change a year that the government has to borrow and spend to keep this clambake going? How about we pull that out of GDP and see what the economy looks like? See any growth? That statement has to be somewhere in the top five foot-in-mouth comments of all time.

The fact that this sort of tripe passes for the crème de la crème of journalistic excellence is one of the main reasons Americans are so clueless about this brave new world we live in. Most have the gut feeling that something isn’t right, but then read an article like the one referenced here and shrug, having given it the college try, and go about what they were doing.

Not all Propaganda

Despite all the misdirection we’ve analyzed above, there is a key statement in there, which does have an awful lot of merit and that is the comment regarding the lack of alternatives. Stocks have outperformed pretty much every conventional asset so far this year – and for some time before that. Commodities, some of which represent a more honest means of storing wealth, have been trashed. During the recent rout of silver, JP Morgan was responsible for roughly 94% of the selling, almost all of it in the paper markets. And the list goes on. Bonds have been stagnant to slightly down, and for most investors, that concludes the list of asset class options: stocks, bonds, and commodities.

The bottom line is that wealth must be stored in something. It can be in cash, gold, silver, stocks, bonds, real estate, and any number of other assets. While there is nothing wrong with putting some of that wealth into stocks, it must not be done blindly. It is the financial equivalent of putting your head into the lion’s mouth. Can you get it out fast enough when the jaws start closing? The people in Cyprus found out the hard way.

It is increasingly my opinion that this is nothing more than a giant trap. All one has to do is consider recent developments regarding the disposition of client assets in the case of brokerage failures, the re-classification of depositors to unsecured creditors and the biggest market rally in history and it is easy to conclude that the trap is being set for another massive consolidation of wealth. This one will rival that of the 1930s in scope and magnitude. The fact that we’re being given no quarter means this is going to be a big grab.

Euphoria and Complacency are Back

The two key components of any major top are euphoria and complacency. People get giddy as I said in the outset and, more dangerously, they begin to believe that the rally will never end and they let their guard down.

In the past few months, Fidelity Brokerage Services LLC, the retail brokerage business for the fund-management giant that has more than 14 million client accounts, said more money has been flowing into stocks and mutual funds.

"People's confidence is coming back," said Ram Subramaniam, president of Fidelity Brokerage Services, adding that the amount of client money that flowed into stocks last quarter is about two-thirds higher than it was a year ago.

Bill Brasuell, a 77-year-old retiree in Key West, Fla., said he has never felt better about the stock market. He recently let the last of the bonds in his portfolio mature, and has rolled the proceeds into stocks.

Note the above rather subtle implication that there are only two ways to ‘invest’ – stocks and bonds.

The investoriat is doing what it does best – buying the top. We can go back just a few short years and find the same kind of irrational exuberance – no credit to the lackey Greenspan – that we found in real estate. Or we can go back to 1999 and find the same ingredients surrounding tech stocks. We know how all that ended. This will be no different and once again a massive amount of wealth will have changed hands. It will be taken from those without the foresight to hang onto it and taken by those who are bold enough to lay their plans bare for the world to see and dare us to say it ain’t so.  Well, Jimmy Stewart is long gone, and I’m saying it ain’t so.

When the next big grab happens, many will have their fine friends in the mainstream to thank for misinforming them, but ultimately they can look in the mirror to find who is ultimately responsible for the poor stewardship and resulting loss of their wealth.

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.