Wednesday, December 11, 2013

I think this is an excellent synopsis of the "risk" case to the current market.

In particular, there are 2 graphs that I find telling - the job #'s from Russell 2000 companies and the the gap in loans versus bank assets.  It is frustrating to say the least that the stimulus is not finding it's way into the economy.

To me, it is clear it is pushing up asset prices - and here I am not talking about only the bond purchases, but the low rate environment.

It is a very thorny problem.  Does one go to cash to protect their position and potentially miss out on a continuation of the bull market?  It is very difficult to stand on the sidelines and watch the market go up every day and not participate.

No easy answer here.  I am uneasy, but also look at the objective numbers and find nothing wrong about the valuations, but that is relative to where interest rates are.  Recall that I look at earnings yield relative to 10 year bonds.  Right now, we stand at about 6.25% versus the 10 year at 2.75, so the spread at 3.5% would have me in stocks.  But, what if rates were at a more "normal" level?  say 4% (growth of 2% plus inflation 2%).  Well, that would put stocks at a not so cheap level.  To normalize to the current 3.5% spread, that would put the multiple at 13.33 and with earnings around 110, then the index at 1466 (or about 20% lower).

Unfortunately, this type of analysis can make one a chicken little.  Markets can stay irrational longer than one thinks.

So do we ride the wave?  Or batten down the hatches?

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