Wednesday, May 22, 2013

End of stocks' bull run?

10:32 AM. As I write this, we may be seeing the end to the stock market's bull run. No, I am not too eager to look foolish by making a call that would be both wrong and memorable. Nonetheless, I am witnessing a momentous occasion and simply had to write about it.
Federal Reserve Chairman, Ben Bernanke, is at this moment testifying in front of the Joint Economics Committee of Congress about the state of the Federal Reserve accommodations and the economic outlook. This is something that has gathered great expectations from market participants even when the general public is probably oblivious to it. At stake is the continued stimulus support by the Fed. If they decided to end Quantitative Easing or any component of it, the market would have no more reasons to continue to climb.
composite image of Federal Reserve Chairman Ben Bernanke speaking to congress at left and the S&P 500 futures chart reacting to his speech at right.
There are major risks hidden behind the recent rise on equity prices. Most dividend paying companies, those that are going up in value most, have gargantuan shortfalls in their pension funds due to ballooning entitlements an unusually long low-interest environment. For example, Delta, a company that has gathered momentum as the whole airline industry has seen renewed appreciation for their stock shares, has pension liabilities equal the whole value of the company. In order to solve the problem, they are hoping for an increase in interest rates. But even substantial increases in interest will not be enough. They will have to use cash from future earnings to moderate their pension shortfall. This will not affect their future profits but will destroy their cash position; and we are talking about a lot of cash.
Because other companies are in the same position as Delta, we should expect for dividends to come dramatically down. Since present stock prices take into consideration dividends, it is almost certain that these valuations will come down as dividends suffer. The question here is not whether this will affect stock prices but when.
In order for prices to stay the same, corporate profits or the premium that investors are willing to pay for them would have to rise. Because most of the money chasing stocks higher today is risk-adverse, the probability of the higher premium is almost not possible. This leaves us with profits going up. Here, remember that much of present corporate profit performance has been due to two factors. First, companies have been taking advantage of low interest rates to borrow to buyback shares of their stock. This increases the per share profit performance. These companies have bought at a rate of about $1 trillion worth of their shares per year. The stock market is about $18 trillion in size. My gut feeling is that they would not be able to continue this for long.
The other thing that has helped improve profit performance is directly related to the massive decrease in payroll that has taken place over the last five years. But how far can you cut payroll? At some point companies have to begin hiring; making this technique least sustainable.
If the stock market ends at near the opening price for today, we might have seen the top. That this would coincide with Bernanke's presentation is not abnormal. The Fed's tactics have pushed risk-adverse money into riskier assets. These funds are looking for the smallest indication of change to exit the market.
They say that no one rings a bell at the top. So, I can not say that I heard any bells. Nonetheless, the day seems like a reversal kind of day.
What does the market mean to average people? Nothing directly; everything indirectly. The White House has continued to press regulations and fear onto business at such furious rate that corporations have refused to commit to long term investments. This means that the country will lose the ability to sustain a strong middle class every day more. Not only are we seeing lousy economic performance, but we can expect to see more of the same. I have written extensively about the economic subject recently; most of it has not been optimistic. Witnessing the Federal Reserve consider an exit and seeing the market react does not help. The Fed has been the only good thing going for the country. Now, we may have to face the music. Keep today marked on your calendar. I hope to be wrong.

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