Fed Stimulus Bubble in the Making

Investor’s first read – Daily edge before the open
DJIA: 18,146
S&P 500: 2,129
Nasdaq Comp.:4,956
Russell 2000: 1,177
Monday, July 11, 2016 8:56 a.m.
Something’s gotta give. At no time on record has both the bond and stock market got this close to record highs at the same time.
Some investors are stampeding into bonds seeking safety, others are stampeding into stocks seeking some semblance of a return on their investment.
All stand to get hurt at some point.
The 10-year U.S. government yields1.36%. The average yield on the DJIA is 2.81%. All but Nike (NKE) and Visa (V) of the 30 Dow industrials yield more than 1.36%.
The top 15 yielding Dow stocks average a 3.46% return, or 1.1 percentage points greater than the 10-year treasury.
But those 15 stocks sell at a price/earnings ratio (P/E) of 16.5, well above the norm, and that is based on year ahead projected earnings.
The average price earnings ratio (P/E) for the DJIA based on forward estimates is 16.4. This compares with 24.1 for the S&P 500 and 22.9 for the Nasdaq Composite.
The BIG money won’t be buying stocks to capture a 1.1 percentage point edge over the 10-year treasury. It will be using the panic to sell at all-time highs as they cash in on yet another bubble – Overdone Fed stimulus.
Earnings will be released in coming weeks. Along with that, the Street will have to deal with revisions of future earnings and corporate guidance. Expect those to be lower than projected.
A stronger U.S. dollar stands to adversely impact Q3 and Q4, S&P 500 earnings, which the Street was counting on to justify these prices.
Earnings projections for Q2 call for a drop of 5.3% vs. an estimate of a drop of 2.8% three months ago. While oil and related industries account for much of this decline, nine sectors have lower growth rates now than at Mar.31. This would bring the P/E for the S&P 500 to 16.4 compared to a 5-year average on 14.6 (data FactSet.com). A Q2 decline would be the first time Y/Y earnings have declined five consecutive quarters since Q3 2008 – Q3 2009, the Great Recession.
This market has good reason to go down. For one, the broad-based S&P 500 is overpriced heading into a Q2 earnings that are projected to be even worse than expected three months ago.
The uncertainties of the presidential election have been ignored, as well as the possibility that the EU will dissolve.
But markets that are ready to go down, waste no time doing just that.
So far this market is hanging tough, obviously transfixed by a Fed policy that has done little to generate business activity since the 2008-2009 meltdown days.
The hint that interest rates will remain low for a year or longer has forced investors to buy yield stocks, even at lofty levels.
When a correction does come, it will be one like August 2015 or January 2016.
Panic-time. Convinced the Fed will keep interest rates at historic lows indefinitely, some investors and institutions are driven to buy stocks where they seek a better yield and the potential for some appreciation. Other investors and institutions only seek the safety of U.S. treasury bonds.
The buying of both has driven each up unrealistically.
Neither low interest rates here, nor negative interest rates abroad, have done little to ensure meaningful growth in their respective economies.
The looming contagion to own both investments stands to end in the near future, with a lot of investors getting hurt.
I can’t see bond prices going much higher without a breakdown in the EU, and a rush to the safety of governments. Stocks can go higher, since extremes at market tops tend to run to the absurd, before peaking.
It is very hard to see any negatives when other investors are making the kind of quick money that is made in the later stages of a bull market. The tendency is to stay just a little longer and make just a little more money before bailing out.
The problem is the initial decline of a major decline is seen as an opportunity, as are subsequent declines. Selling is out of the question until losses reach the pain point, which is often somewhere near a bottom. Humans being humans !
SUPPORT “today”: DJIA:18,049, S&P 500:2,118; Nasdaq Comp.:4,926
RESISTANCE “today” DJIA:18,297; S&P 500:2,146; Nasdaq Comp.:4,995
On occasion, I technically analyze each of the 30 DJIA stocks for a reasonable risk, a more extreme risk, and an upside potential over the near-term. I add the results of each, then divide by the new DJIA “divisor” (0.14602) to get the DJIA for those levels. This gives me an internal check on the DJIA itself, especially if certain higher priced stocks are distorting the averages.
As of July 11, 2016, a reasonable risk is 16,970 a more extreme risk is 16,812. Near-term upside potential is 18,579.
(I will repeat this regularly to keep readers aware of the potential for an April correction)
The market is tracking a pattern for presidential election years where an administration is in its second term.* The news is bad.
Historically, these markets have declined in Jan./Feb., rallied in March then topped out in early April, plunged in May with brief rallies in June and August and a plunge into October prior to the election.
 STATUS OF MARKET: Neutral – but very, very vulnerable. Expect volatility
 OPPORTUNITY: RISK: Risk high, Profit taking justified.
 CASH RESERVE: 45%. Consider 75% now if tolerance for risk is low.
 KEY FACTORS: Outlook for Q2, and 2016 earnings questionable. Fed has market under its spell.
Note: Source of weekly economic calendar and good recap of indicators: mam.econoday.com.
George Brooks
Investor’s first read
A Game-On Analysis, LLC publication
Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer. Neither Game-On Analysis, LLC, nor George Brooks is registered as an investment advisor. Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

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