The Dow Jones index of blue chips has made several hesitant thrusts to
all-time highs. Tuesday, the Dow closed up 56.94 at a new record of 11,727.74.
The risk of war with Iran seems to have dropped, at least until after the
November election.
Oil prices have dropped to $58.63 per barrel and still look weak. Some are now
forecasting oil at $45 per barrel — a prediction Financial Intelligence Report
made when oil topped $78 a barrel.
Corporate profitability is up and people are buying the Dow, especially the
non-tech stocks. Much of the buying is through ETFs.
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But is this a good time to sell into the rally?
Market bulls argue that price to earnings ratios (PE) are still low — meaning
the market can rise even higher.
Relative to the PEs of 2000, today's PEs do look cheap.
But, 2000 was the top of an all-time boom, not a historic average. Today's
average Dow PE is near the high end of the historic average of 16.
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Normally, U.S. stock markets fall because of Fed induced interest rate
increases. In the wake of 9/11, the Fed started to lower interest rates. Many
investors flooded in, forgetting it was in fact a fall in profitability,
not
increased interest rates that had caused the fall. Most investors were
disappointed in repeated false rallies, sparked by continued falls in interest
rates.
In recent years, corporate profitability has increased greatly, but as the Fed
started to raise interest rates, the markets held back and remained flat,
recovering only by some 70 percent in face of a near doubling in profitability.
Again, stock buyers were focused, in an old fashioned manner, upon interest
rates, rather than profitability.
Amongst those who remained focused, we believe correctly, on profitability were
corporate treasurers. They bought back corporate "treasury stock" in record
amounts. Meanwhile, many potential investors stayed more or less on the
sidelines. Some invested in cash and some in real estate. Stock markets remained
flat.
Now, that the Fed has put its tightening policy on "hold" and with U.S. economic
numbers looking weak, there is talk of the Fed lowering rates.
This has sparked the recent move in the Dow. But this recent upward movements
has been hesitant, by historic standards. Furthermore, it has not been supported
by other broader markets, particularly not by the more aggressive sectors.
The S&P index, (with a far larger market cap than the Dow) is still some 12.5
percent off its 2000 high. The market cap of Microsoft is still almost 50
percent off its 2000 high.
Market commentators say that it is profitability that has driven the market up.
For example, Mr. Rudolph-Riad Younes, co-manager of the Julius Baer
International Equity Fund — arguably one of the best-managed funds in the world
— says current stock markets are unsustainable.
Since 2002, Younes has offered stock picks for Barron's. These picks are up over
40 percent each year since then. His equity fund is up 17.5 percent each year
for the past five years, strongly outperforming the S&P.
While Wall Street sees euphoria today, Younes sees worry and risk.
In a recent interview in Barron's, Younes said corporate profit margins are at
record highs — 100 percent above their historical average.
Younes argues that if corporate profitability were to fall to historic average
levels, today's market prices would equate to PE ratios of some 30 times
historic earnings.
This would make the present market look very, very overpriced at present levels!
With the housing bubble unraveling in the U.S., we could easily see an
unraveling of corporate profits.
Younes concludes: "Add to that the global imbalances around the world, and
equities are not a very safe place to be."
