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Not Seeing Signs Of Market Exuberance? Look Closer.

  • Written by Syndicated Publisher No Comments Comments
    July 15, 2014

    Geopolitical unrest in Iraq/Ukraine? Buy stocks.  

    Unemployment drops to 6.1%? Buy stocks.
    Loss of 500,000 full-time jobs? Buy stocks.
    GDP falls by much more than expected? Buy stocks.
    Q2 economic rebound much weaker than originally estimated? Buy stocks
    Rising/falling oil prices? Buy stocks.

    Over the last few months, it has not mattered whether the news flow has been positive, negative or indifferent; the refrain has been simply to “buy stocks.” Lord Overstone once said:

    “No warning can save people determined to grow suddenly rich.”

    The more the markets rise in the face of negative news, the more “confident” that individual investors become in their own abilities. The lure of becoming “rich”overwhelms logical thinking creating a “willful blindness” to rising investment risks.

    When casinos first open their doors they “loosen” the slot machines so that they payout more often. Players are attracted by the whirling lights and buzzers that denote a sea of“winners.” As individuals play, and win, they begin to become “confident” in their “skill” of playing a slot machine.  The “can’t lose” psychology begins to overwhelm the logic that the odds of winning are roughly 1-in-264,000 or higher.

    Eventually, when enough “fish are in the barrel” the casino begins to “tighten up” the machines to put the “odds” in the favor of the house. As players begin to lose more often than they win, they keep playing under the assumption that their “cold streak” is about to end.  Moreover, just “as soon as they get back to even” they will quit playing. Eventually, out of money, they do leave the machine. There is truth behind the saying“The house always wins.”

    This analogy is what we see in the stock market today. The actions by the Federal Reserve to suppress interest rates and inject liquidity into the system have most definitely tilted the current “odds of winning” into the player’s favor. With asset prices being lofted higher, the “hawkers” stand on the media street corners shouting: “Ladies and Gentlemen, step right up and try your luck. Stocks are the only game in town.”

    Of course, as the markets have risen in the face of adversity, weak fundamentals and economic growth, the “can’t lose” mentality has fostered excessive confidence in the player’s abilities. Of course, this has always been the psychological cycle of investors over time and the reason why individuals always wind up “buying high and selling low.”

    Investor-Psychology-Cycle-062414

     Signs Of Exuberance

    I recently discussed the “potential melt-up” in stocks as investors migrate into the“irrational exuberance stage” of the investing cycle. Yesterday, Dr. Ed Yardeni also made similar comments in his blog stating:

    “One of the great virtuosos of the investment business was Sir John Templeton. He observed that bull markets experience four phases: pessimism, skepticism, optimism, and euphoria.

    Where are we now in the current bull market? In my opinion, we are moving from the third to the fourth phase for the S&P 500. The first phase started on March 9, 2009 and ended after the second and worst correction of the bull market, on October 3, 2011. The second phase included three minor corrections, with the last one ending on June 1, 2012. The third phase has had no corrections and is probably coming to an end now. It may be setting the stage for what can also be called the ‘melt-up’ phase.”

    Also Read: Are We Entering The 3rd Stage Of A Bull Market?

     Yardeni-4-phases-bullmarket-070914

    The entrance into the “euphoria” stage is marked by investors “blind willingness” to take on excessive risk due to the expectation that the “can’t lose” scenario will continue indefinitely. Take a look at some recent commentary of investor actions:

    Neil Irwin via NYT:

    “In Spain, where there was a debt crisis just two years ago, investors are so eager to buy the government’s bonds that they recently accepted the lowest interest rates since 1789.

    In New York, the Art Deco office tower at One Wall Street sold in May for $585 million, only three months after the going wisdom in the real estate industry was that it would sell for more like $466 million, the estimate in one industry tip sheet.

    In France, a cable-television company called Numericable was recently able to borrow $11 billion, the largest junk bond deal on record — and despite the risk usually associated with junk bonds, the interest rate was a low 4.875 percent.”

    Irwin Kellner via WSJ MarketWatch

    “Dow is now a whopping 155% above its low back in March 2009…For one thing the economy has not grown anywhere near as much as stocks over the past 5-1/3 years; neither have corporate profits.”

    S&P-500-GDP-Ratio-070914

    “This bull market has managed to avoid a correction for 33 months — far longer than average. And correction or no, the current bull market is the fourth-longest since the Crash of 1929.”

    Tim Price via Sovereign Man Blog

    “Case in point – CYNK Technology Corp, a listed company that as of this morning has a market capitalization in excess of $1 BILLION.

    According to official filingsthe social media development company had one employee, no website, no revenue, no product, and no assets.”

    Miles Johnson via Financial Times

    “The percentage of stocks that have been borrowed by short sellers – who try to profit from a company’s share price falling – has dropped to the lowest level in the US, UK and the rest of Europe since the years before the collapse of Lehman Brothers, according to data compiled for the Financial Times by Markit.

    The fall in short selling comes as Wall Street and markets in Europe trade at near record and multiyear highs, indicating that while some high-profile hedge fund managers have warned of excessive market euphoria the industry is still unwilling to bet against the rally.

    Camilla Hall via Financial Times

    “US lending to businesses is reaching record levels but banks are privately warning that the activity should not be seen as evidence of an economic recovery.

    Much of the corporate lending is going to fund payouts to shareholders, finance acquisitions and fuel the domestic energy boom, bankers say, rather than to support companies’ organic growth.

    As Steen Jakobsen at Saxo Bank recently stated:

    We have a generation of traders and investors who see any dip as a buying opportunity and policy makers who argues everything being equal, it’s better to have a stock market bubble than disorderly markets and depression.

    My bigger point here is that this is not ‘different times’, the system’s low volatility will be replaced by higher volatility, the zero bound leads to bubbles by definition unless you of course believe in eternity and most importantly, mean-reversion and compounding remains the two most powerful tools in finance.”

    When markets enter into the “euphoria” stage, there becomes a mass hypnosis over market participants. Those that speak of such silliness as “corrections,” “overvaluation,”or “risk” are routinely “burned at the stake” for their “bearish heresy.” It is at this point, where the masses have come to accept that the current environment is infinitely sustainable, that things will change. Ultimately, it is the sting from the sharp slap of reality that reminds investors that “risk” is more than a board game.

    If you are not seeing signs of “exuberance” in the markets, it is only because you are not looking closely enough. 

    lance sig
    Lance Roberts

    Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of “The Lance Roberts Show,” Chief editor of the X-Factor Investment Newsletter and the Streettalklive daily blog. Follow Lance on FacebookTwitter and Linked-In

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.
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