It’s being a tough slug for the equity bears over the past couple of years. The last few months have been especially confusing as US stocks have been impervious to the quickly decaying global economic fundamentals. I know that there are many different inputs that determine equity prices, but this last move higher has been remarkably divorced of any traditional relationship to the fundamentals.
I am not some perma-bear that can only see the negatives. But at the same time, neither can I climb aboard a rising market simply because of the positive price momentum.
Although many ZeroHedge types are quick to point to the Fed jawboning as the source of the recent US equity market strength, I contend that it is actually the Japanese who have been driving the recent stock market rally.
It is my long held belief that the move off the October 15th lows in the S&P 500 was the result of the change in policy at the Bank of Japan and the Japanese Government Investment Pension Fund (GIPF). The decision by the BoJ to increase their QE program at the same time the GIPF executed a monster asset shift out of JGBs into equities has been the driving factor in the rally of the past four months.
Have a look at the trading of the USDJPY rate versus the S&P 500 future:
The US equity market trades almost tick for tick with the Japanese Yen. This relationship is no coincidence. The Bank of Japan’s balance sheet expansion is getting directly ploughed into US stocks via the asset shift at the world’s largest pension plan.
The BoJ’s balance sheet expansion is truly mind blowingly large. It easy to get numb to the big numbers that these Central Banks throw around, but have a look at this chart o the major Central Bank’s total assets in relation to their country’s GDP.
The Bank of Japan is monetizing their debt at a level that is not really appreciated by most investors. Even less understood is how this newly created money is pushing up US equities.
Well, I say that it is less understood, but I have recently noticed a big change in attitude in regard to the sustainability of the recent stock market rally. I was listening to Bloomberg radio the other day and the head US equity strategist from Goldman Sachs was being interviewed. Whereas last year all that passed as analysis was extrapolations of the uptrend, this time the strategist was decidedly less sanguine about the US equity market’s prospects. The strategist was actually bearish, citing research that showed the median US stock is about as expensive as it has ever been. The takeaway was that stocks were richly priced and bound to disappoint.
This new found realization that US stocks are expensive can be summed up best with Wells Capital’s Jim Paulsen’s recent quote:
Most U.S. stocks, however, are much more expensive than suggested by the S&P 500 Index. The median New York Stock Exchange (NYSE) stock is currently at a postwar record high P/E multiple, a record high relative to cash flow, and near a record high relative to book value!
It takes a while, but some smart investors are finally waking up to the fact that the relentless drive higher in US equity prices at the same time that the global economy is rolling over might not be the greatest risk reward for long investors.
The Japanese last bought US assets in size during the late 1980s at the height of their bubble. They famously over paid for Pebble Beach golf course and ended up selling it back to the Americans for something like half of what they paid at the top. My suspicion is that they are busy making the same mistake today. We are going to look back at the GIPF’s goosing of equity markets and kick ourselves for not giving it to them with both fists.
As for timing, Friday’s action in the stock market was extremely poor. We opened at the highs and closed at the lows. The rallies are increasingly being sold instead of the dips being bought. I shorted some S&Ps on Friday, and although we have gapped up this morning, I am going to be selling more in the coming day or two.
I don’t buy the argument that stocks are the only game in town and you need to be long. I think that everyone is already long, buoyed by the GIPF buying of the last few months and as that buying slows, the market could experience its Wile E. Coyote moment.