In This Stock Market, Don't Drink the Kool-Aid

By: Money_Morning

Michael E. Lewitt writes: Stocks hit new records last week as central banks around the world continued writing checks to prop up still struggling economies, the price of oil stabilized, Vladimir Putin lured the West into a phony truce in the Ukraine, and Athens and the EU tried to pretend that Greece isn't hopelessly insolvent or that it even matters if it is or isn't.

In other words, investors were once again all too willing to ignore economic reality and drink the Kool Aid being served by central bankers and politicians.

We might as well call this the "Jonestown Market" because the cult leader Jim Jones could just as easily be handing out paper cups filled with colored water and investors would be swilling it down…

A Planet of Debt

Investors no longer require good news to cause them to bid up the prices of grossly overpriced equities. All they need is the promise that central banks will keep printing funny money to send them running to call their brokers.

And why not? This formula has worked great for the past six years. Why shouldn't it work again?

I will tell you why. Six years ago the world has much less debt than it does today. It was also much more stable geopolitically than it is today. It also had yet to create a bubble in the energy sector, the social media sector or the biotech sector.

Stocks were trading at rock bottom valuations and credit instruments were trading as though the world were about to go out of business.

Today, the world is home to more than $100 trillion of debt that can never be repaid and $700 trillion of derivatives whose risks very few people understand. There is massive overcapacity in global commodities. Stocks and bonds are grossly overvalued and priced for perfection.

So that is why central banks incessantly printing paper money to cover over the inability of governments to create sustainable economic growth is not going to work this time.

And why investors who keep buying stocks indiscriminately rather than hedging their heroic gains of the past six years and focusing on select, undervalued stocks are going to get their heads handed to them sooner or later.
Money Destruction Is Accelerating Now

Even worse, the U.S. dollars they are using to buy these stocks are being actively destroyed by the Federal Reserve's policies. The dollar may be appreciating against other paper currencies like the euro and the yen, but in the end it is just another paper currency and is being actively debauched by America's own central bank.

But the whole world has gotten into the money destruction game. In recent weeks, 12 more central banks have eased policy including the European Central Bank, Switzerland, Denmark, Canada, Australia, Russia, India, and Singapore.

And don't forget the kamikaze mission that Japan's central bank launched last Halloween. In many of these regions, interest rates are now negative, which means that capital sitting in banks is eroding by the day.

Policy failures are rampant yet they are celebrated by stock investors who have the attention spans of fruit flies. Whatever gains they enjoy today are going to be decimated tomorrow when the consequences of these policies come home to roost.

When the Fed Will Hike Rates

The U.S. economy is not accelerating, contrary to what the Happy Faces being paraded on financial news networks are telling people; it is actually slowing. But investors don't have time for facts. They are too busy sprinting headlong into disaster.

Last week, the Dow Jones Industrial Average (INDEXDJX) added 195 points or 1.1% to close at 18,019.35 while the S&P 500 (INDEXSP) closed at an all-time record high of 2096.99 after popping by 2% o4 42 points. The Nasdaq Composite (INDXNASDAQ) is once again trying to regain its Internet Bubble level, adding 149 points last week or 3.2% to end the week at 4893.84.

Bonds sold off as the yield on the benchmark 10-year Treasury ended the week back over 2%, rising 8 basis points to 2.02%. The yield is still 15 basis points lower than it began the year. Investors continue to debate the timing of the Fed's first rate hike.

My money is still on June as there is little reason for the Fed to keep rates at zero in the current environment. As disappointing as the recovery has been, zero interest rates are not the answer.

Stocks were powered by a big move in Apple, Inc. (Nasdaq: AAPL), which gained 6.9% to close at a record $125.65 per share, giving the company a market capitalization of $740 billion. Of course, that isn't enough for Apple shareholder Carl Icahn, who called for the stock to trade at $216 per share in a self-serving letter that he released to the public. That would give the company a market cap of $1.3 trillion or almost twice its current value, which already ranks as the highest valuation ever achieved for a public company.

In contrast, Tesla Motors, Inc. (Nasdaq: TSLA) tanked after reporting disappointing fourth quarter earnings. Tesla remains an absurdly overvalued stock trading at 40% of the market cap of General Motors Company (NYSE: GM) while manufacturing a fraction of the number of vehicles as the auto giant. GM is coming under attack from activist investors and is considering undervalued by many.

Whatever You Do, Don't "Rock the Bubble"

Tesla CEO Elan Musk, scrambling to meet the carnival-barking promises he keeps making to investors, made the absurd argument to the press this week that his company should be worth in ten years what Apple is worth today – $700 billion. The SEC used to throw corporate executives in jail for making those types of statements; in a stock market bubble, they just ignore them.

And we are in a bubble even if it isn't as big a bubble as the last one. The forward multiple on the S&P 500 has jumped from 16x earnings at the beginning of the year to 17.5x earnings today. How did it do that? All it took was analysts, who are always behind the curve, to lower their 2015 earnings estimates for the S&P 500 to account for lower oil prices and a higher dollar and for investors to keep bidding up stock prices and the multiple melted up. The historical average forward multiple is 14x.

But before we start comparing multiples today and in the past, we need to remember that today's earnings are inflated by stock buybacks, low interest rates and phony stock option accounting (primarily by tech companies). As a result, comparing current and historical multiples isn't really comparing apples-to-apples.

This subtlety is lost on most investors, which is one reason why the market keeps rising. But earnings estimates are continuing to drop for 2015 for a variety of reasons.

With the Fed likely to raise rates before the end of the summer, the stock market is definitely not priced for what is coming. Investors should enjoy the party when it lasts because it is going to create one heck of a hangover.

Source :http://moneymorning.com/2015/02/15/in-this-market-dont-drink-the-kool-aid/

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