The Morning Call--Stocks are overvalued even under a 'miracle' scenario

The Morning Call

10/19/12

The Market

           

    Technical

            The indices (DJIA 13548, S&P 1456) had a roller coaster day, though they closed within their primary trends: (1) short term uptrends [13443-14274, 1443-1535] and (2) the intermediate term uptrends [12572-17572, 1325-1923].   I continue to focus on the recent highs (13653/1469) as a tell on whether stock have topped out or will make another leg up.

            Volume fell; breadth deteriorated.  The VIX was off fractionally, finishing again within the zone between the upper boundary of its short term downtrend and the lower boundary of its intermediate term trading range.  It closed below its 50 day moving average for a third day in a row (a bullish sign for stocks).

            GLD sold off but remained above (1) the interim support level and (2) the lower boundaries of its [a] short term uptrend and [b] intermediate term trading range.

Bottom line: the Averages stalled below their recent highs (13653, 1469).  I don’t believe one day’s hesitation necessarily means the assault on those highs is over; or even if this challenge is over that stocks won’t remain in the area roughly defined by 13302/1422 and 13653/1469.  That said, I continue to believe that stocks are ahead of themselves and remain focused on our Sell Discipline.

           

            Bullish sentiment declines (short):

            http://www.bespokeinvest.com/thinkbig/2012/10/18/individual-investors-ring-the-register.html

    Fundamental

    

     Headlines

            Yesterday’s economic news was a mixed bag: dramatically higher weekly jobless claims but an equally surprising advance in the leading economic indicators as well as the Philly Fed index.  Particularly positive was the leading indicators which kept alive this week’s string of very positive datapoints. Granted the weekly jobless claims number was disappointing; but that was offset by the Philly Fed and last week’s nonfarm payroll report.  So the near term economic outlook continues to brighten.

The leading economic indicators and Philly Fed index held early sway with investors in trading as stocks advanced through the morning, helped along by Chinese third quarter GDP coming in on target (there is lots of concern out there that the Chinese economy is rolling over).

            Then in the early afternoon, Google’s earnings were released prematurely and they were not good.  This caught investors by surprise and they sold the Market down.

            Largely ignored was another euro summit taking place in Brussels to determine the fate of Greece and Spain.  That is not particularly surprising since these guys almost never do jack s**t anyway (and according to the overnight news, they didn’t---again) and even if they do, they lie about it.  However, what does surprise me is that investors continue to allow them to fiddle while the continent burns around them.

            Here is some of yesterday’s menu of EU troubles:

            Nazi’s gaining strength in Greece:

            http://www.zerohedge.com/news/2012-10-18/are-neo-nazis-aiding-greek-cops-diy-law-enforcement

            And self immolation in Italy:

            http://www.zerohedge.com/news/2012-10-18/man-self-immolates-front-romes-presidential-palace

            And longer term:

            The euro is a spectacular failure (medium):

            http://www.nakedcapitalism.com/2012/10/yanis-varoufakis-the-euro-crisis-as-a-spectacular-political-failure.html

            And its end may be nigh (medium):

            http://www.zerohedge.com/news/2012-10-18/small-printed-note-saying-wait

Bottom line: the continuing run of surprising improvement in the economic datapoints notwithstanding, stocks are, in my opinion, overvalued except on a set of Herculean assumptions which include our elected representatives taking a firm course to correct the current irresponsible fiscal policy, the Fed successfully removing its massive injection of liquidity without stimulating inflationary pressures and the eurocrats somehow managing to ‘muddle through’. 

Don’t get me wrong; all of the above may happen.  The question is, how much money should one bet on it?   My answer is the with roughly 50-60% of our Portfolio  invested in US stocks, that is plenty.  To be sure, when, as and if our political class actually do something untoward like doing the right thing for the electorate, I will be happy to alter the assumptions in our Models as well as the asset allocation in our Portfolios. 

Until I see proof, nothing changes.  And by the way I am not worried about missing out on a sudden explosion of investor enthusiasm when it appears that reforms are coming for the simple reason that those reforms will cause pain.  Our economy is broken just like a leg is broken; and while fixing it (setting the bone, putting in pins if necessary) promises a brighter day, it won’t happen over night and walking again will not be without its ups and downs.

Just remember the deterioration in the economy that occurred under Johnson (guns and butter), Nixon (price controls), Ford and Carter (rampant inflation), the steps that Reagan and Volcker had to take and what happened to the economy and the Market subsequently.  In the end, they produced the start of a great period of prosperity and a fantastic bull market; but getting there wasn’t so fun.