The week ended on a down note, with the S&P registering a 0.5% loss for the week. Volume was low, as would be expected for the holiday shortened week. And volatility inched up, also as would be expected for a week that ended with a loss. What was most surprising was the fact that for the first time in five straight years, the S&P did not jump on the first day of trading of the new year. The last time that happened was when the global financial crisis was about to unfold.
Technically, the slight dip from last week did very little to change the fact that the S&P is extremely over-bought. At this point, it would take almost 100 S&P points to reverse this condition and make it somewhat, but still not extremely, over-sold. The S&P is now officially more over-bullish than it has ever been in recorded history; the difference between bulls and bears has never been higher. And there are almost no bears left out there. Since almost everyone is a bull, almost everyone who wants to be ‘in’ this market is now in it. And valuations, as measured by the Shiller PE ratio (now almost 26), have never been higher except for a brief period during the tech bubble and 1929, just before the stock market crashed.
Economically, the story for the US economy is still unchanged—it’s limping along, without generating strong growth. Last week, pending home sales disappointed. The Dallas Fed manufacturing survey missed, as did the Chicago PMI report. Consumer confidence was better than expected. ISM manufacturing only met expectations, as did consumer spending. It was a short week, and nothing really new emerged among the economic data to suggest that the economic picture is changing in any way.
Meanwhile, around the world, the reality on the ground is still fairly somber as opposed to the prices of stocks and bonds which have been soaring. It seems that the Wall Street vs Main Street dichotomy has been spreading globally.
In Europe, most of the peripheral states are stuck in a mild depression. Unemployment rates are sky-high, and economic growth has been abysmal….much worse than in the US. Sure the ECB has helped prevent sovereign debt crisis (for now) from flaring up, but the fact is that European debt is still soaring (vs. GDP) and there has been no economic recovery for most of the continent.
In Asia, China continues to slow in terms of growth. But the bigger story is that it’s government debts have ballooned over the past five years and are now starting to cause problems for the economy. It’s looking like it will be more difficult for China to artificially boost growth going forward by pumping more credit into its economy and it may even become difficult for China to manage the trillions of dollars of debts that it has already accumulated.
Japan, meanwhile, has succeeded in boosting goods inflation—via Abenomics—but it hasn’t been able to boost wages. This means that its people are now struggling even more to pay for most costly goods and services with incomes that are no longer keeping pace. All the while, Japanese government debt is still soaring; soon it will hit 250% of GDP, a shockingly high ratio, rarely seen in history, and even then always related to fighting major wars.
With a slowdown in Asia, Australian and Brazilian exports have been hit hard, and this has been reflected in the drop in the currencies of these two states.
With the rising threat of the Fed tapering, gradually at first, beneficiaries of hot money flows are suffering from capital flight. One of the hardest hit major markets is India, which has suffered from a collapse in its currency and all the pressures associated with that (eg. soaring costs of energy imports).
The middle east is still a simmering pot of instability. The Iran problem (nuclear weapons) has not been solved. Syria has not been solved. And recently, the Egyptian problem has re-emerged.
Behind the scenes, the global financial system is as fragile as ever. In a recent article, the former prime minister of the UK, Gordon Brown, argued that almost all of the problems that led to the global financial crisis in 2007-2008 have NOT been solved.
So while the last 12 months have been relatively calm, it seems that a repeat of this ‘smooth sailing’ over the next 12 months would be nothing short of a miracle.