Where Does This End

In late 2007 the market did not look pricey based on expected earnings. However, those earnings expectations were based on a continued real estate and debt bubble. As we now know those earnings never materialized once the bubbles bursted. We are in a similar situation now where stocks are not historically expensive versus expected earnings but the economy is being held together by many unsustainable influences.

Current earnings are based on an economy where the US government is running a trillion dollar deficit, municipalities are spending well beyond their means, the Fed is printing money, insolvent banks are being propped up as are sovereign nations etc..

This does not mean we are headed lower as the same could have been said in 2005 and 2006, yet the market continued higher. The question to ask is how will we know when when this unsustainable situation will end? I believe the answer is higher inflation and higher interest rates. Current policies will eventually lead to higher inflation. That will force the Fed to step off the gas at which point higher interest rates will start to choke the economy. Oil above $100 a barrel or food price hikes being passed through in earnest would put serious pressure on the Fed and eventually on the stock market.

I believe the market is currently overvalued based on the level of sustainable economic activity. I understand that many people want to go along for the ride. The key is to understand that one is playing a game of musical chairs  and the day will come when the music stops.

1 comment:

nicasurfer said...

If we are headed for higher inflation which i believe then buying precious metals on pull backs is a great trade