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US Market Reaches Dangerous Historical Highs

Dec 1, 2016


What a difference a couple of weeks make.

On 9 November, markets were down and out.

With Trump in the Oval Office, the world was coming to an end.

Fast forward 16 days and the Dow Jones has reached new all-time highs.

The All Ords is up 6%.

And all this against a backdrop of rising bond (interest) rates...

Apparently, the much-maligned 'Donald' is now going to be good for business.

All the cash that corporate America is going to bring back will apparently do wonders for the economy...or at least that's what Main Street believes.

Maybe. Maybe not.

In 2004, the US Congress passed an act to enable multi-nationals to repatriate foreign profits back to the US and pay only 5.25% in taxes.

How did that work out?

The Wall Street Journal reports (10 October 2011):

  • 'Repatriation Tax Holiday a "Failed" Policy

    'The 15 companies that benefited the most from a 2004 tax break for the return of their overseas profits cut more than 20,000 net jobs and decreased the pace of their research spending, according to report from the Democratic staff of the Senate Permanent Subcommittee on Investigations released Monday night.'

The repatriated money was used to pay dividends and finance share buybacks and takeovers. Playing the creative accounting game.

Build businesses. Employ staff. Don't be stupid. Not when we have share bonus schemes that need to be exercised.

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While some people are looking for all that overseas loot to boost the economy, the insiders know that if it comes back, the accountants are going to have a field day creating earnings that have no bearing to actual business revenue.

This is what has Wall Street salivating...another source of capital to keep the illusion alive.

But do not be fooled. That cash is not coming back anytime soon. What Trump says and what Congress approves are two very different things.

The US share market is in dangerous territory. Each new high makes the market cheerleaders joyous, but it should make prudent investors nervous.

This table compares a number of valuation and economic data sets between the previous market high in September 2007 (and we know what followed that) and now.

To quote from the report:

  • 'It's back to the future - again. Leverage has returned, most notably in the corporate sector where debt metrics have not just round-tripped, but are now in excess of the levels experienced before the Great Recession.'

Lessons have not been learned. The addiction to debt is even greater than it was in 2007.

The US share market - and that means global markets - is more exposed to an event that could prove to be far more devastating than 2008/09.

But is anyone in the mainstream - financial media, investment institutions, or financial planners - warning investors to tread warily?

No. But that's to be expected.

They also said nothing back in 2007...sorry, they did say something: 'Shares for the long term'. The All Ords is still 20% below its 2007 peak.

The following extract from my soon-to-be released book, 'How Much Bull Can Investors Bear?' explains why you'll never receive any advance warning from the investment industry on the perils that are building within the market.

  • 'Let's rewind for a moment and look at the period leading up to the market top in 2007. It really was an easy sell for the investment industry. Share markets had returned, on average, 15% per annum (growth plus dividends) for nearly 25 years. Interest rates had fallen from over 16% to around 4%. Little persuasion was needed to encourage investors to swap their cash for shares.

    'There were the occasional hiccups in the growth story - the 1987 crash and 2000 "tech wreck" - but bad news was marketed as good news. These periods (and subsequent recoveries to newer highs) were later used as evidence to convince doubters of the market's resilience. The mantra of "the market always recovers" was born, and the uptick in the charts was all the proof needed to confirm this assertion.

    'Revenue streams were based on a percentage of funds invested. All industry participants clipped the ticket and enjoyed rising levels of income and profitability.

    'It's now nine years since the Australian market topped out in late 2007.

    'In spite of the massive amounts of central bank intervention, there remains an uneasy calm with markets.

    'Each week there appears to be a mix of good and bad news - markets up, then down. The bouts of volatility earlier this year unsettled investors. The central bankers calmed investor nerves with the promise of more rallied strongly.

    'The mere hint of a 0.25% interest rate rise in the US sends markets into a lather. Taking the prospect of a rate rise off the table is cause for jubilation on Wall Street.

    'People (especially those close to, or in, retirement) are of two minds as to whether they sell now, realise their gains and/or losses and go to the safety of cash, or whether to maintain their allocation to shares (and possibly buy more) to participate in the central banker engineered market recovery.

    'The conditioning from 25 years of rising markets, in addition to a widespread belief in the omnipotence of central bankers, holds enough sway to make the latter seem a viable proposition.

    'In this period of perceived "stability", the investment industry's marketing efforts have moved into overdrive.

    'There have been countless articles headlined with common themes like: "Shares offering fair value"; "high dividend yield stocks to buy"; "maintain a long term share market view"; "invest in value stocks"; "protect your portfolio with defensive stocks"; "is there a better time to invest in the market?"; "money in the bank is wasted"...and they go on and on ad nauseum.

    'Financial planners are using high profile economists and industry commentators as guest speakers at client seminars to reassure investors that all is OK.

    'The main thrust of the industry's marketing message is best summarised as: Shares are good value, cash is trash, and when it comes to shares, it is either a bad time to sell or a good time to buy.

    'No stone is left unturned in the efforts to convince investors to stay the investment course.

    'Industry super funds buy airtime to promote, in bold print, their superior past performance (with the small print caveat of "past performance is not a reliable guide of future performance") as a means to attract more dollars to manage.

    'We are constantly told "it's time in the market, not timing the market" that delivers the best long-term results. At best this is a we will explore later in the book.

    'As stated earlier, the industry players, whether they realise it or not, are fighting for their survival. A loss of investor faith in the market's ability to deliver superior performance will see their industry suffer the same fate as the Thanksgiving turkey.

    'There are two points worth considering with the current situation the industry finds itself in:
  1. It's obvious the fortune of the share market plays an integral role in the investment industry's prospects. A prolonged downturn in the Australian share market would expose the industry as an expensive one-trick pony. If the share market goes lame, then the easy-fee circus is largely over. Without the performance of the share market to sell, the industry will find it difficult to maintain its relevance.
  2. Can you ever recall hearing the analysts, industry commentators and economists, who are now telling us the market is "good buying at these levels", making any pronouncements in 2007 about the market being overvalued and telling investors they should sell? No. The hypocrisy is galling.
  • 'The next serious - and I suspect more severe - market downturn is certain to test investors' belief in the market's resilience and powers of recovery. Unfortunately, when this happens, it'll be another case of being wise after the event. Repenting in leisure is no way to spend your retirement.

    'To enable investors to make informed choices, does the industry dare tell the truth about the share market's long-term (secular) cycles before the next downturn occurs, or will it continue to use selective data to support its own interests ahead of yours?

    'The answer to that question lies in the old saying, "In the horse race of life, the horse named 'self-interest' always wins by a nose."

    'You must question the investment industry's status quo. Otherwise you risk making a mess of your financial situation...a mess that could take years, or decades, to resolve.

Believing the headlines is fraught with danger.

People believed Trump would lock up 'crooked Hillary'.

People believe all the cash that Apple and Google have overseas will make America great again.

It'll make major shareholders even richer, but I doubt that Middle America will benefit too much.

People believe all the infrastructure spending will create jobs. Wrong. The US does not have the labour capacity to undertake this work. Those jobs - ironically - will go to foreign construction companies.

People believe too much and think too little.

The financial industry knows this, which is why their marketing efforts are concentrated on pushing the agenda - shares, growth, and funds under management.

There are times when that agenda is a valid one to pursue.

However, there are times when blind pursuit of an agenda based on self-interest can inflict a great deal of harm on those who believed and trusted you.

Based on historic valuation models, the US share market is at a very dangerous level.

Be careful. Exercise caution.

When this market crashes, there is unlikely to be any quick spite of what the industry tells you.

Please note: This article was first published in The Daily Reckoning Australia on November 26, 2016.

Vern Gowdie is a contributing editor to Money Morning - Australia's biggest circulation daily financial email. Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia. Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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