Submitted by Lance Roberts of STA Wealth Management,
With just a tad more than three weeks left in the year it is time to start focusing on what 2014 will likely bring. Of course, what really happens over the next twelve months is likely to be far different than what is currently expected but issuing prognostications, making conjectures and telling fortunes has always kept business brisk on Wall Street.
1) 5 Reasons The Market Will Rally Again In 2014 via MSN Money
Jamie Dlugosch presents his case for another bullish year in the stock market.
The Federal Reserve
Fear In Market
Stable Geopolitical Climate
2) 6 Things That Could Cause The Market To Drop 20% via 24/7 Wall Street
RBS says stocks could rise 30% next year. A slew of other investment banks and market analysts may not be that optimistic, but there is plenty of talk about the Dow Jones Industrial Average at 20,000 and the Nasdaq at 5,000. It has been a long time since a market correction of 10%, 15% or even 20%. Optimists say there is no catalyst for such a plunge. Pessimists mostly have been shouted down, but probably not with entirely good reason.
There are several factors that could undermine the market's phenomenal run. Most are obvious, but experts have chosen to ignore them.
The most important six are these:
1. The battle over the federal budget and debt ceiling debate
2. Holiday spending could likly be weaker than expected.
3. Energy prices rise.
4. Fourth quarter earnings come in weaker than expected.
5. Markets will correct sooner or later...because they always do.
6. Investors seem to forget that unemployment around 7% is historically high.
The market will correct soon, unexpectedly, and it will be ugly.
3) 7 Reasons To Be Cautious via Pragmatic Capitalist
In a recent piece by Doug Kass at TheStreet.com he highlights some reasons to be cautious about the equity markets. I don't like the concept that "everyone is in the pool", as he mentions, because it implies something like the "cash on the sidelines" fallacy, but I do think his piece is well thought out and worth considering. I've attached his 7 reasons to be cautious:
1. "The median price-to-revenue ratio of the S&P 500 is now at an historic high, eclipsing even the 2000 level.
2. The Shiller P/E is above 25, exceeding all observations prior to the late-1990s' bubble except for three weeks in 1929.
3. Market cap-to-GDP is already past its 2007 peak and is approaching the 2000 extreme. (This ratio is stretched at over two standard deviations above its long-term average.)
4. The implied profit margin in the Shiller P/E (denominator of Shiller P/E divided by S&P 500 revenue) is 18% above the historical norm. On normal profit margins, the Shiller P/E would already be 30.
5. If one examines the data, these raw valuation measures typically have a fraction of the relationship to subsequent S&P 500 total returns as measures that adjust for the cyclicality of profit margins (or are unaffected by those variations), such as Shiller P/E, price-to-revenue, market cap-to-GDP and even price-to-cyclically-adjusted-forward-operating-earnings.
6. Because the deficit of one sector must emerge as the surplus of another, one can show that corporate profits (as a share of GDP) move inversely to the sum of government and private savings, particularly with a four- to six-quarter lag. The record profit margins of recent years are the mirror-image of record deficits in combined government and household savings, which began to normalize about a few quarters ago. The impact on profit margins is almost entirely ahead of us.
7. The impact of 10-year Treasury yields (duration 8.8 years) on an equity market with a 50-year duration (duration in equities mathematically works out to be close to the price-to-dividend ratio) is far smaller than one would assume. Ten-year bonds are too short to impact the discount rate applied to the long tail of cash flows that equities represent. In fact, prior to 1970, and since the late-1990s, bond yields and stock yields have had a negative correlation. The positive correlation between bond yields and equity yields is entirely a reflection of the strong inflation-disinflation cycle from 1970 to about 1998."
Read the whole thing here
4) What Keeps Me Up At Night by Bill Gross
I have written often that QE does not boost economic growth and that the artificial inflation of assets actually has deflationary effects
. The comments by Bill Gross are critically important to this point.
Yet this now near 5-year migration across the global asset plains in search of taller grass and deeper water has had limits, both in price and real growth space. If monetary and fiscal policies cannot produce the real growth that markets are priced for (and they have not), then investors at the margin – astute active investors like PIMCO, Bridgewater and GMO – will begin to prefer the comforts of a less risk-oriented migration. If they cannot smell the distant water or sense a taller strand of Serengeti grass, astute investors might move away from traditional risk such as duration as opposed to towards it. Deep in the bowels of central banks research staffs must lay the unmodelable fear that zero-bound interest rates supporting Dow 16,000 stock prices will slowly lose momentum after the real economy fails to reach orbit, even with zero-bound yields and QE.
5) Proof That Shiller's CAPE Works via Mebane Faber
"I've been publishing CAPE updates for countries quarterly on The Idea Farm, and below I highlight a blurb from our upcoming year end outlook. This chart shows the returns to country ETFs and the 10 cheapest and 10 most expensive markets. Notice why I was so unpopular in Bogota in January when I said they have one of the most expensive markets in the world! Also notice the big outlier in the expensive country bucket (the US). Due to all of the expensive countries declining and the US appreciating, we are now the most expensive in the world."
6) Risk Parity = "Snake Oil In New Bottles" via Zero Hedge
Nearly a year ago, we penned "Return = Cash + Beta + Alpha": in which we performed "An Inside Look At The World's Biggest And Most Successful "Beta" Hedge Fund. The fund in question was Bridgewater, and Bridgewater's performance was immaculate... until the summer when the sudden and dramatic rise in yields as a result of the Bernanke Taper experiment, blew up Bridgewater's returns for 2013 and at last check, at the end of June, was down 8% for the year. As further explained in "Yield Speed Limits" And When Will "Risk Parity" Blow Up Again", an environment in which rates gap suddenly higher (and in the current kneejerk reaction market all moves are purely in the form of gaps as risk reprices from one quantum to another in milliseconds) is the last thing Ray Dalio's strategy wants. Be that as it may, and successful as Dalio's fund may have been until now, tonight James Montier of Jeremy Grantham's GMO takes none other than Bridgewater to task, in a letter in which among other things, he calls risk parity "just old snake oil in new bottles", and sums up his view about the strategy behind Bridgewater in the following equation:
Risk Parity = Wrong Measure of Risk + Leverage + Price Indifference = Bad Idea
and proceeds to skewer it: 'At a fundamental level, risk parity is the antithesis of everything that we at GMO hold dear. "
Read Full Critique From GMO.
Just For Fun - Wall Street Stupidity Index via CNN Money
The day Twitter went public not only was profitable in the fiscal sense, but also illuminated a metric that has heretofore been underappreciated by those attempting to comprehend and thereby profit from the laws that guide the market. We will call this potent new tool the Wall Street Stupidity Index.
Have a great weekend.