Market Fundamentals are Wrong

The market is overpriced, the only thing driving the present rally is hot money created out of thin air by the Fed's money-printing policies.
Hot money can flood into assets quickly - pushing the market up 60% since March. But this type of money can also flood out of assets just as fast. It's because hot money is made up of traders trying to turn a quick profits. They hope to buy now and sell to a greater fool later on. It's a recipe for disaster. When these traders think they've become the greater fool, they'll sell everything in the blink of an eye.

The US banking sector is in shambles. Banks like Goldman and JP Morgan with large trading operations are profitable again. But banks still won't lend, according to Nobel Prize winner Paul Krugman. Writing in Sunday's The New York Times, Krugman had this to say about the state of the banking sector:

      “But there's an even bigger problem: while the wheeler-dealer side of the financial industry, a k a trading operations, is highly profitable again, the part of banking that really matters - lending, which fuels investment and job creation - is not. Key banks remain financially weak, and their weakness is hurting the economy as a whole.

      You may recall that earlier this year there was a big debate about how to get banks lending again. Some analysts, myself included, argued that at least some major banks needed a large injection of capital from taxpayers, and that the only way to do this was to temporarily nationalize the most troubled banks. The debate faded out, however, after Citigroup and Bank of America, the banking system's weakest links, announced surprise profits. All was well, we were told, now that the banks were profitable again.

      But a funny thing happened on the way back to a sound banking system: last week both Citi and BofA announced losses in the third quarter. What happened?

      Part of the answer is that those earlier profits were in part a figment of the accountants' imaginations. More broadly, however, we're looking at payback from the real economy. In the first phase of the crisis, Main Street was punished for Wall Street's misdeeds; now broad economic distress, especially persistent high unemployment, is leading to big losses on mortgage loans and credit cards.

      And here's the thing: The continuing weakness of many banks is helping to perpetuate that economic distress. Banks remain reluctant to lend, and tight credit, especially for small businesses, stands in the way of the strong recovery we need.”

In other words: If the economic fundamentals don't hold up, banks won't lend, consumers can't spend, and job losses continue. What is driving this new rally? Of course the worldwide stimulus packages and artificially low interest rates.

“This double trouble is setting us up for the next crisis,” says Financial Times columnist Wolfgang Münchau. By his calculations, “the US equities market was overvalued by 35% to 40% in mid-September. And it's been soaring since then.”

Through low interest rates, central banks are encouraging investment into risky, speculative sectors - as REITs, junky financial stocks, and highly leveraged companies - in attempt to keep the hostage to fortune economies from falling to tatters.

“When central banks eventually have to raise rates and governments halt stimulus, a severe depression could ensue. And if they keep the easy money flowing, Münchau believes the depression might be much worse:

      This, I believe, would cause the mother of all financial market crises - a bond market crash - to be followed by depression and deflation.

From where we are now, the central banks can take no course to avoid a sharp correction.”

To get a closer look at the green shoots, compare below data provided by Contrary Investor and Zero Hedge.

  “   1.) Year over Year Retail Sales Growth: 9.3% average, 5.3% now

      2.) Consumer Confidence: 95.5 average; 53.1 now

      3.) Capacity Utilization: 79.9% average; 66.6% now

      4.) Year over Year Industrial Production: 4.1% average; -10.7% now

      5.) ISM: 53.9 average; 52.6 now

      6.) Payroll employment gains over period: 2.2% average; -2.0% now

      7.) Decline in continued unemployment claims from cycle peak: -26.3 average; -11.6% now

      8.) Year over Year growth in total credit market debt: 9.3% average; 3.0% now

      10.) Year over Year growth in household debt: 8.8% average; -0.1% now

      11.) P/E Multiple: 16.8x average; 20.0x now “

The comparison provides a stark reminder that government actions, not fundamentals, are driving the present equity bubble.

"An alternative lesson from the double dip the economy took in 1938 is that the GDP created by massive fiscal stimulus is artificial. So whenever it is eventually removed, there will be significant economic fall out. Our choice may be either to maintain large annual deficits until our creditors refuse to finance them or tolerate another leg down in our economy by accepting some measure of fiscal discipline." – says David Einhorn, of Greenlight Capital