Articles tagged with: QE

More Irrational Exuberance?

Has unchecked optimism inflated asset values?

“Irrational exuberance.” That phrase – uttered by Federal Reserve Chairman Alan Greenspan in 1996 and reputedly coined by economist Robert Shiller – has become part of the investment lexicon. Now and then, bears reference it – especially when the market turns red-hot.

Late last year, many Wall Street investment strategists thought the S&P 500 would advance about 5.8% in 2014. They were wrong. As 2014 ends, the broad benchmark is poised for another double-digit annual gain. Asked to explain the difference, bearish market analysts might point to irrational exuberance.1

Irrational exuberance – the run-up of asset values due to runaway enthusiasm about an asset class – reared its head catastrophically in 2000 (the tech bubble) and in 2007 (the housing bubble). In the first edition of his book of the very same title (2000), Shiller warned investors that stocks were overvalued. In the second edition of Irrational Exuberance (2005), he cautioned that real estate was overvalued. The fact that he’s trotting out a third edition of the book in 2015 was some people a little spooked. 2,3

Has quantitative easing (QE) bred irrational exuberance once again? As a 2011 Forbes.com headline put it, “Trees Don’t Grow to the Sky – Even with the Fed Behind Them.” You could argue – quite convincingly – that the Fed has propped up the stock market since 2008, and that the great gains of this bull market were primarily a result of QE1, QE2 and QE3.4

No further easing, no further gains, the logic goes (or least not gains resembling those seen in recent years).

As 2014 ends, bears insist that stocks are greatly overvalued. To back up their argument, they point to recent movements in the CAPE (Cyclically Adjusted Price-to-Earnings) or P/E 10 ratio. This closely-watched stock market barometer (created by Shiller and his fellow economist John Campbell) tracks a 10-year average of the S&P Composite’s real (inflation-adjusted) earnings.5,7

(If you’re wondering what the S&P Composite is, it is a historically wide, big-picture window on the U.S. equities market that unites data from the S&P 500 – which has only existed since 1957 – with prior S&P indices.)6

Since 1881, the P/E 10 ratio of the S&P Composite has averaged about 16.5. At the peak of the dot-com bubble in 2000, it hit 44.2. It stumbled to a low of 13.3 when the market bottomed out in March 2009, but it was up at 26.5 as December began, about 60% above its historic mean.5

Why should this concern you? This P/E 10 ratio has only topped the 25 level three times – in 1929, 1999 and 2007.7

But isn’t the market healthy & ready to stand on its own? That’s what the bulls insist, and given the S&P 500’s 2.45% rise for November following the end of QE3, they may be right. Ardent bulls contend that another secular bull market began in March 2009 – history just hasn’t confirmed its secularity yet.8

In fact, Shiller himself recently noted that even though the high P/E 10 ratio is troubling, it has been mostly above 20 since 1994. (Low bond yields may explain some of that.) A numeric gap from 26 to 20 is decidedly less alarming than one from 26 to 16.7

Whatever occurs, remember that stocks don’t always go up. (Home prices don’t always ascend either.) The longer a bull market progresses, the more challenges it overcomes, the greater the chance that this particular reality of equity investing may be lost.* While diversification does not protect against marketing risk or guarantee enhanced overall returns, it may pay to diversify your portfolio across asset classes for this very reason, now and in the future.

Mike Moffitt may be reached at ph# 641-464-2248 or email:  mikem@cfgiowa.com

website:  www.cfgiowa.com

Michael Moffitt is a Registered Representative with and Securities are offered through LPL Financial, Member FINRA/SIPC. Investments advice offered through Advantage Investment Management (AIM), a registered investment advisor. Cornerstone Financial Group and AIM are separate entities from LPL Financial.

 *Stock investing involves risk including loss of principal.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

   Citations.

1 – blogs.wsj.com/moneybeat/2014/11/23/a-sign-of-health-for-stocks-cautious-2015-forecasts/ [11/23/14]

2 – money.cnn.com/2005/01/13/real_estate/realestate_shiller1_0502/ [1/13/05]

3 – irrationalexuberance.com/main.html?src=%2F [12/8/14]

4 – forbes.com/sites/etfchannel/2011/01/20/trees-dont-grow-to-the-sky-even-with-fed-behind-them/print/ [1/20/11]

5 – advisorperspectives.com/dshort/updates/PE-Ratios-and-Market-Valuation.php [12/1/14]

6 – advisorperspectives.com/dshort/updates/Validating-the-SP-Composite.php [12/8/14]

7 – tinyurl.com/pwungau [8/18/14]

8 – online.wsj.com/mdc/public/page/2_3023-monthly_gblstkidx.html [11/30/14]

 

 

 

 

Income inequality and your investment account

A new article came out recently stating that the top 1% of the world population controls $110 trillion of wealth. http://www.oxfam.org/sites/www.oxfam.org/files/bp-working-for-few-political-capture-economic-inequality-200114-summ-en.pdf . I understand that many folks consider this a travesty, but before they get too excited about righting this inequality of wealth, they need to actually “run the numbers” and try to avoid being a hypocrite.

Upon doing a little math, I found many of my clients are in that top 1%. That’s right! Before you get too impressed, consider this: the richest 1% globally control $110 trillion of wealth. There are 7 billion people on earth, so $110 trillion divided by 7 billion equals about $1.5 million each. A farmer client who owns 240 acres of Iowa land (a small farm for those who might not know) or a small business person who owns her business debt free, along with a home and a $500,000 401k, could also fall in that 1%. Heck, a person who can save $275/month and increases that with the inflation rate can get to $1.5 million by retirement age.¹

So to be more fair to the less rich, let’s just take from the “super rich”. That would probably do it, right? Well, according to Forbes list of richest people in the world, the top 50 have roughly $1.2 trillion of wealth.² If you confiscated ALL their wealth, it wouldn’t come close to paying down the total public (government) debt in the world of $52.6 trillion (http://www.economist.com/content/global_debt_clock). It wouldn’t even pay the interest on the debt! And, the $1.2 trillion spread out evenly over every man, woman and child on earth, would give everyone $171.43. Would that pay your cell phone bill for 5 months? Or if you confiscated ALL the wealth of the top 1 percenters and spread it out evenly, everyone would get $15,714.28. For those in third world countries who face REAL poverty, that’s certainly a lot. But in the U.S., although it’s considered poverty, it’s not enough to help most people for any length of time.

How does this affect your investments? When the government attempts to help those in poverty, it spends money on social programs. Since it doesn’t currently bring in enough money through taxes, it borrows the difference from investors with help from the Federal Reserve (our banking system in the U.S.)

Our Federal Reserve creates money out of thin air (“prints” money to increase the money supply) and has been using that money to buy U.S. government-backed debt. That extra money enters our economy.³ Some of it ends up in the hands of citizens. Some spend it, but some save it. For those who save it, some ends up being invested in stocks, some in their businesses, and some in real estate, among other places. This typically pushes asset values higher, which makes those people appear richer….on paper.

They may not be poor but many of them saved that money themselves and they don’t consider themselves rich. When the stock market last crashed, in 2008-2009, many of those people lost nearly 50% of that wealth. Not all of those folks were born with a silver spoon in their mouth. Their plans for a successful retirement hinge on a decent 401k and Social Security. And Social Security is funded by a trust fund expected to be exhausted in around 20 years, with the source of this information being the 2013 Annual Reports summary on the Social Security website itself (http://www.socialsecurity.gov/oact/TRSUM/tr13summary.pdf) and run by a government that is $17 trillion in debt (http://www.treasurydirect.gov/NP/debt/current). The unfunded (future) liabilities of the United States government are projected to be over $127 trillion…more than $1.1 million for every taxpayer alive today.4

So as easy as it is to despise rich people, not all are evil and taking from them won’t come close to solving the problem anyway. And as much as we’d like to think government is the answer, not all government is good and as the debt increases, it probably means much larger problems and much less wealth for everyone when the bubbles pop again like some did in 2008-2009.

Towards that end, we run what-if stress testing scenarios for our clients simulating multiple economic events that could impact their life’s savings, helping them understand the very REAL consequences of actions by governments, terrorists, and the like. Being informed about, and in charge of, your portfolio is the best way to understand and deal with the certainty of uncertainty that affects our life.

Finally, if you really think that rich people have more influence over government than poor people, you may be right. But by that logic, we should all vote for smaller government. There would be fewer people in the government to influence and a chance to reduce the federal debt, which may help save Social Security in the future for us and our kids. If we achieve wealth equality, we’ll need it!

¹annual interest rate 7.5% for 45 years, increasing contributions by an inflation rate of 2.5% and compounding annually. For illustrative purposes only. Not based on any specific investments. Investing in securities involves risk, including potential loss of principal.

² http://www.forbes.com/billionaires/list/

³http://www.independent.com/news/2012/feb/25/how-us-federal-reserve-creates-and-destroys-money/

4http://www.usdebtclock.org/

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal.