Bulls On Parade

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The Hard Assets Alliance Blog

Bulls On Parade

Technically speaking, the US emerged from the Great Recession in June 2009. For many Americans, however, stagnant wage growth and tight disposable incomes have made the last few years feel like anything but your typical recovery. The story on Wall Street is decidedly different, where the S&P 500 and Dow Jones Industrial Average both ended 2013 at all-time highs.

Financial markets rarely mirror their underlying economies. Nonetheless, today’s soaring stock market and the sluggish recovery of the “real recovery” makes this connection seem looser than ever. Of course, the Federal Reserve’s massive stimulus program is the reason asset prices have shot through the roof while economic growth has largely limped along. Despite the obvious link between abundant liquidity and cheap credit and the ongoing rally, investors continue to disregard large systemic risks by diving head first into the market.

In many regards, investors have never been more optimistic. According to Barron’s, the Consensus Bullish Sentiment—a widely recognized measure of investor confidence—kicked off 2014 at 74%, while 55.06% of the respondents to the American Association of Individual Investors (AAII) survey, which tracks the sentiment of individual investors, reported bullish outlooks in the final week of 2013. This is a level that was only surpassed once during the last four-year bull market.

Not only are investors crowding to one side of the boat, they’re also assuming greater risk through the use of leverage. As spotlighted in last month’s featured chart, margin debt on the NYSE now exceeds a critical level only previously tested in the run-up to the dot-com and housing bubbles of the early 21st century. Although many are interpreting this as a positive development, the fact that more companies went public in 2013 than in any year since 2007 may further signal that most of the easy money has already been made, as insiders unload shares on the less informed public.

Waning Hours of the Party

Swollen profit margins and strong earnings growth are two of the main reasons investors continue to throw caution to wind. Just as negative real interest rates forced investors up the risk curve, Fed policy has padded the profitability of corporate America. If you strip away earnings from financial firms in the S&P 500—which are undoubtedly the primary beneficiaries of the present ZIRP environment—you’ll discover that earnings growth in 2013 was negligible.

Rather than solid fundamentals or bright growth prospects, today’s rich stock valuations are largely due to unconventional monetary policy and the consequent euphoria that accompanies any bubble. To understand just how overbought the market may be, consider how the Shiller price-to-earnings (P/E) ratio for the S&P 500 now exceeds 25: a level that was only previously surpassed in 1929, 2000, and 2007.

As a time-tested, safe-haven asset with a low correlation to financial instruments, gold is an unrivaled contrarian investment at a time when most bears have gone into hibernation. At current prices, the yellow metal presents a truly once-in-a-lifetime buying opportunity. And that’s no bull.

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