The Markets Are “Meh”. And That’s Worrying

The Markets Are “Meh”. And That’s Worrying

“Some participants viewed equity prices as quite high relative to standard valuation measures.”

That line, from the Federal Reserve minutes that came out last night, is copping the blame for stocks pulling a Grand Old Duke of York yesterday.

Having marched to two-week highs in the early part of the US session, stocks then marched back down again after the Fed put out the summary of its musings in last month’s policy meeting.

You may be scratching your head.

After all, it’s hardly news that stocks are looking a bit stretched, is it?

And anyway, we already know the Fed raised its policy rate last month. So it shouldn’t come as a surprise to see they had a reason.

If you are thinking those thoughts, then I agree. However, I also have an “ah, yes, but” in response.

For one thing, the minutes also talk about reducing the size of the Fed’s balance sheet.

In plain(er) English, that means finally selling some of the assets (government bonds, mortgage backed securities) that the Fed has bought up as part of its efforts to support the economy.

At the moment, whenever one of the bonds it holds matures, the Fed reinvests the money. As a result, the asset side of the Fed’s balance sheet continues to have $4.5 trillion of bonds sitting on it.

The fact that central banks have maintained expanded balance sheets for several years has led to some eyebrow-raising equity valuations.

So stock markets are prone to be spooked by any hint that the Fed may soon start to withdraw its support – however justified that might be from an economic perspective.

That’s the first part of my “ah, yes, but”. The Fed is making noises about equity valuations and also dropping hints that it’s ready to start taking away some support.

The other part of my response is that stocks have essentially gone nowhere since the 21 March selloff.

With no obvious trend, traders are apt to jump on any scraplet of news fodder to justify “doing something”.

They’ll find some other catnip today or tomorrow no doubt.

Oh, and just to muddy the waters even more, now there’s a view out there now that because the Fed may start reducing the size of its balance sheet later this year, this will also slow down the pace of interest rate hikes.

Why? Because if the Fed is tightening by reducing its asset purchases, it’ll see less need to tighten via the more traditional tool of raising rates.

So if you’re of the view that higher interest rates would put a dampener on stocks, you can spin this into a bullish development, if that’s your thing.

Like a lot of financial news, the Fed minutes are a Rorschach picture. You can read what you want to read into them.

Still, this all has to be heading somewhere. Markets don’t stay range bound forever.

If this one breaks lower, it could spill over beyond the stock market.

I respect your privacy and will never pass on your email address to anyone else.

Shares go up and shares go down.

If you’re in it for the long haul, you should be prepared to ride these ups and downs.

But as we saw in Tuesday’s DR, we’re seeing warning signs that suggest a version of the 2008 crisis could be on the cards:

  • Banks still haven’t fixed the too-big-to-fail problem. So if a bank gets in trouble, don’t be surprised if panic spreads just as it did nine years ago;
  • Companies have loaded up on debt, encouraged by the low interest rate environment;
  • Corporate defaults are on the rise…

I spoke yesterday about how an absence of “euphoria” is viewed in some quarters as a sign that we’re not actually in a bubble.

Specifically, I cited Jeremy Grantham talking about how investors get overextrapolate from “near perfect fundamentals” to push valuations way beyond what’s reasonable.

Sluggish growth and prolonged, emergency level interest rates mean those strong fundamentals simply aren’t there. And so neither is the euphoria.

That may be true. But I also don’t detect much real fear around either.

It’s all a bit “meh”.

However, while there may not be the “near perfect fundamentals” to fuel bubbly euphoria, there are some pretty ugly fundamental factors around that could justify – what shall we call it? – an “acute malaise”.

So it makes sense to be prepared for a downturn, especially with stocks at these levels.

And not just a downturn in stocks, but an overspill into what people insist on calling “the real economy”.

Your preparations need to go beyond your stock portfolio.

This video explains how to prepare yourself for the next financial downturn.