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Reason #1. Global equities (stock) prices primarily reflect sustained economic growth trends over the long-term, and there are few signs of sustained growth happening any time soon.
The long-term stability and growth of the global economy cannot be sustained, so long as global debt is three times global gross domestic product (GDP), as it stands now. This is the result of decades of fiscal mismanagement, profligacy and just plain overspending on a global scale; it is also a problem that defies an easy or quick fix. In fact, notwithstanding the best intentions of the global economic order to grow out of and de-leverage to reduce that outlandish debt/GDP ratio over the past eight years, the only discernable effect of global quantitative easing and low (even negative) interest rates has been to reduce private debt by making it public, i.e. government/sovereign, debt. That makes global governments today more vulnerable than ever to bankruptcy and many observers believe that the next financial crisis will be ignited by a sovereign debt crisis. High government debt levels and already historic low-interest rates also means that if and when such a crisis should emerge, the same governments that bailed us out in 2008 will be hard pressed to repeat that effort.
In the meantime, all that debt is deflationary and weighs heavily against economic growth, and together with unfavorable demographics, continued globalization and disruptive technological change, it is likely that the USA and all the major economies of the world, including Europe, Japan and China, will face significant economic headwinds.
This predicament is so insidious and so entrenched it is unlikely that anything short of the emergence of a transformational technology, in the way that the widespread use of the internet was in the 1990s, will positively change that outlook for many years to come.
Reason #2. There has been so much deception in and manipulation of economies and the financial markets, it would appear no one really knows where reality begins and fantasy ends.
Stock prices are driven by earnings and price/earnings (P/E) multiples. Global central banks low-interest rate policies have pushed P/E multiples to their upper limits causing markets to rally since 2009, but clearly interest rates can only rise from these levels, so markets will need earnings growth in order to rise to new highs.
Earnings appear to be growing again although it is difficult to assess real earnings growth from that created by the wonders of financial engineering. The low-interest rate environment has allowed (even encouraged) corporations to borrow capital to buy back their own stock, which has managed to shrink their shares outstanding making shares scarce while simultaneously increasing earnings per share. Additionally, many corporations have opted to report earnings according to non-Generally Accepted Accounting Principles (non-GAAP) thereby allowing them flexibility to easily manipulate and inflate those earnings. Non-GAAP earnings have proven to be significantly higher than GAAP earnings.
Those initiatives combined with the willingness of governments and sovereign wealth funds to buy and hold equities seemingly into perpetuity has created an apparent scarcity in supply available in the open market, i.e., no sellers at any price, thereby distorting and raising prices. The widespread growth in Exchanged Traded Funds (ETFs) and other forms of passive investing is further distorting the fair market prices of individual equities.
The health of our economy is also being reported through a filter of false optimism, as government redefines macroeconomic metrics to portray more favorable results in economic growth, employment, inflation, and many other factors. By traditional measures, for example, economic growth has been negative (that is, recessionary) for the past eight years (not the 1-2% as reported)!
Just as the legacies of baseball star Barry Bonds, bicycle racing champ Lance Armstrong and others were tainted by the realization that their performances were “juiced” by the wonders of drugs, so too has the stock market’s performance in recent years been juiced by the wonders of free capital and financial engineering. But unlike their individual performances, whether legitimate or otherwise in the eyes of the public, no one can deny that Barry Bonds broke home run records or that Lance Armstrong won all those bicycle races. Only time will tell whether or not the superior market results produced by all that free money and engineering will be sustained once all that stimulation is gone.
Most disappointing is that market pundits and commentators rarely acknowledge these economic and market differences by making historical comparisons which are irrelevant if not disingenuous. In fact, with few exceptions, they comment on market movements as if they are moving freely and completely unencumbered by extreme global government intervention and manipulation.
Reason #3. The markets appear to be in the very late innings of a secular market rally in prices. By most traditional metrics markets are inflated if not approaching all time highs in many cases. (Using traditional metrics, they are at all-time highs!)
Historical analysis indicates that when market valuations are so stretched, very low returns can be expected in the following decade. That fact, combined with the fact that the US market has not sustained at least a 5% price pullback for nearly 9 months, the longest period since 1996, and longer than all but four periods occurring since the Great Depression, increases the odds that a price correction is coming. Consequently, one must assume that the downside risk from this point forward is potentially much more significant than is the upside potential.
Any one of these reasons should make investors pause, but all three taken together make a compelling case for investors to exercise extreme caution when considering making new investments in the equities market. In summary, the economic backdrop for investing is treacherous and likely to remain so for many years, market values are inflated by any measure, and with all the manipulation and misinformation it is difficult to assess exactly where investments stand at this juncture. This is not to suggest that investors sell all their holdings, as no one can know how long this charade can continue, and history has shown that markets can remain irrational longer than one might expect. However, prudent investors should consider harvesting some investment gains and trimming their current equity holdings, especially in areas that have sustained significant gains in recent years.
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