The Stock Market Bubble

Back to the Future on Wall Street
by MIKE WHITNEY


Wall Street is buzzing, and it’s all about bubbles.

In fact, according to Google Trends, interest in the term “stock bubble” was higher in November 2013 than anytime since October 2008.

And that should be expected given that the Dow Jones just broke through the 16,000-mark while the NASDAQ sailed-past the 4,000 milestone for the first time in 13 years. And did I mention that S&P 500 just closed above 1,800 for an all-time high?

While surging stocks are not proof of a bubble, they do draw attention to the condition of the underlying economy which is still in deep distress 5 years after the recession "ended." With "official" unemployment at 7.2% (and real unemployment twice that figure), GDP barley growing, droopy personal consumption, flagging durable goods, shrinking revenues, flatlining wages, falling incomes, widening inequality, plunging consumer sentiment, 47 million Americans on food stamps, and myriad other signs of persistent economic stagnation; the so called “recovery” is anything but robust. So where are stocks getting the oomph to keep rising?

That’s not a question that bothers the bubble deniers who have started popping up on the business channels like they did prior to the housing and the dot.com busts. These so called “experts” assure the public that all the bubble talk is just scaremongering by disgruntled Cassandras who don’t understand that current valuations are reasonable. They say that soaring prices reflect “strong fundamentals.

Uh huh.

Last week, serial bubblemaker, Alan Greenspan, made an appearance on Bloomberg TV where he scoffed at the idea of a stock bubble saying, “It’s a little on the upside, (But) “This does not have the characteristics, as far as I’m concerned, of a stock market bubble.”

There you have it from Maestro himself. No bubble here. Move along now.

Others, however, are not as confident as Greenspan. They think stock prices have less to do with fundamentals than they do with the Fed’s uber-accommodative policy which has kept short-term rates set below the rate of inflation for 5 years straight, providing a subsidy for risk taking. They also point to Fed chairman Ben Bernanke’s $85 billion per month asset purchase program, called QE, which has expanded the Fed’s balance sheet by $3 trillion lifting stock and bond prices across the board. Stock prices are based on Central Bank intervention. Fundamentals have nothing to do with it, nothing at all.

As for the bubble; judge for yourself:

Margin debt on the New York Stock Exchange is currently at its highest level ever. It’s even higher than before the crash in 2007. When investors borrow a lot of dough to buy stocks, you’re in a bubble, right? Because that’s what a bubble is, tons of credit pushing up prices. And when something bad happens, like the Lehman Brothers default, then all the over-extended borrowers have to dump their stocks pronto, which causes firesales, panics and financial meltdowns. Been there, done that.

So why is there so much margin debt now, you ask?

Because of zero rates. Because of QE. Because speculators think the Fed will keep prices high by pumping more liquidity into the system. It’s called the Bernanke Put, the belief that the Fed will prevent stocks from falling too fast, too far. Margin debt is a reasonable reaction to the Fed’s policy, which is why the Fed is ultimately responsible for the risky behavior.

Now check this out from the New York Times:

“Since the dark days of 2008, the Nasdaq has risen more than 150 percent, twice as much as the old-school Dow industrials. Money has been pouring into social media stocks. As of Friday, Twitter had risen nearly 60 percent since it went public only a few weeks earlier.

Once again, new “metrics” are being applied to justify stratospheric valuations. Twitter is losing money. A price-to-earnings ratio? There is no E in the P/E. But its stock is trading at 20-odd times the company’s annual sales. Good enough….

Eight months ago, Snapchat was valued at $70 million. Today, it is valued at $4 billion, even though it has zero revenue. Six months ago, Pinterest was valued at $2.5 billion. Today, it is valued at $3.8 billion — and no revenue there, either. And last week news broke that Dropbox was said to be seeking a new round of funding that would value the company at $8 billion, up from $4 billion a year ago.” (“Disruptions: If It Looks Like a Bubble and Floats Like a Bubble”, New York Times)

Did you catch that? A company with zero revenue is worth $3 billion more today than it was 8 months ago. So we’re back to the bad old days of the dot.com bust. This is the result of low rates and QE. It has nothing to do with fundamentals. We’re not talking earnings here. We’re talking manipulation, intervention, and central planning.
 
Then there’s this from the Wall Street Journal:

“Investment funds aimed at individual investors are barreling into collateralized loan obligations, a complex and volatile type of security that was shaken by the financial crisis.

Lured by annual returns of as high as 20%, some mutual-fund managers are buying CLOs through investment funds that purchase stakes in loans to companies with low credit ratings…. …

The biggest buyers of these securities usually are hedge funds, insurers and banks. But mutual funds and business-development companies, which pitch themselves to individual, or retail, investors, have collected more than $60 billion in money from clients this year, according to Keefe, Bruyette & Woods, Inc. and fund-data provider Lipper.

CLO returns are higher than on corporate bonds and other loans, but CLO prices could plunge if the risk rises that companies will run into trouble repaying their loans. That happened in 2011, and some fund managers say retail investors are mostly unaware that the firms they invest in are buying CLOs…” (“Volatile Loan Securities Are Luring Fund Managers Again”, Wall Street Journal)

So the big boys are climbing further out the risk curve to scratch out a higher rate of return on their investments; investments which–by the way– will eventually cost ”retail investors” (you and me) a bundle. 

 

And the reason these financial institutions are engaging in such risky behavior is because rates have been stuck at zero for 5 years, forcing them to look for higher yield wherever they can find it. It’s all part of the Fed’s Pavlovian conditioning. First you turn the interest rate dial to zero, then you juice stock’s prices with QE. And then you wait for the suckers (Mom and Pop) to reenter the market so you can cut them down like corn stalks in a combine. Works every time, just take a look:

“One development that has experts concerned is the return of individual investors, who are known for getting into the stock market near peaks…One way to measure their activity is to look at net inflows into stock mutual funds (excluding exchange-traded funds). When investors put more into stock funds than they take out, it’s called a net inflow. When they withdraw more than they invest, it’s a net outflow.

This year, net inflows totaled $176 billion through Nov. 20, according to Lipper…Most of that money is coming from bank accounts and money market funds…”

So the sheeple are about to get sheared again, right? Just like Bernanke and his Wall Street buddies planned from the get go. But, guess what? Just as Mom and Pop are getting back into stocks again, the big boys are getting out. Take a look at this report from BofAML from the Macronomics blogsite:

”BofAML clients were net sellers of US stocks for the fifth consecutive week, in the amount of $2.3bn. Net sales were led by institutional clients, who returned to net selling following a week of muted buying.

Institutional clients remain the biggest net sellers year-to-date, with cumulative net sales of over $23bn—larger than in either 2008 or 2010. …..Hedge funds were also net sellers for the second consecutive week, while private clients returned to net buying after a week of selling. This group has been a net buyer for 23 of the past 26 weeks.” (“Credit: All that glitters, ain’t gold”, Macronomics)

How do you like that? So once the chickens get lured back into the henhouse, the door slams shut and the fox fires up the stove for another big feed. Isn’t this how it always works out?

Now check this out in Forbes about ”cov lite” loans:

“Covenant-lite loan activity in 2013 is smashing all records, and appears to be picking up speed. Through Aug. 8 there has been $162 billion of covenant-lite loan issuance in the U.S., more than five times the amount seen at this point in 2012, and easily topping the $86 billion of cov-lite deals logged all of last year.” (“Cov lites” soar to new record”, Forbes)

Unfortunately, cov lites are a particularly lethal form of lending which strips “typical lender protections” from credit agreements. Here’s the scoop from the New York Times:

“Leveraged loans became popular before the 2008 collapse but nearly disappeared afterward, regarded as a symbol of unbridled lending. But they started to return in 2010 and are now back in force, with volumes of $548.4 billion this year through Nov. 14, already exceeding the precrisis level of $535.2 billion in 2007.

The type of leveraged loans that Learfield took out are known as covenant-lite, financial lingo for loans that lack the tripwires that could alert investors to any potential financial troubles at the company that could affect repayment. More than half of all leveraged loans issued this year have been the so-called cov-lite types, double the level seen in 2007 on the eve of the credit crash.” (“New Boom in Subprime Loans, for Smaller Businesses”, New York Times)

So, let’s recap: The Fed has managed to spark another surge in risky lending (that “exceeds precrisis levels”) that threatens to blow up in investors faces leaving them less prepared for retirement than they are today.

Check.

And there’s more. Take a look at the recent stock buyback frenzy, which is where companies buy their own stock to goose the price instead of investing in plants, equipment, hiring, or any other type of useful, productive activity. This is from Bloomberg:

“Multiple expansion through share buybacks have been driving indeed the stock market higher greater than earnings have. …. Buybacks rose by 18% Quarter-over-quarter to $118 billion in 2013, up 11% year-over-year to $218 billion.”  (Bloomberg)

Even so, Greenspan sees no bubble. Stock prices are based on good old fundamentals, like earnings. What could be more fundamental than earnings, right?

Take a look at this from the Testosterone Pit:

“Corporate earnings will grow this year at their lowest level since 2009. Revenue growth at public companies is almost non-existent. Companies are buying back stock at a record pace to boost per-share earnings.”  (“What Really Bothers Me About this Stock Market”,  Michael Lombardi, Testosterone Pit)

Huh? So earnings aren’t so hot either?

Apparently not. And that means the fundamentals are actually weak, which makes sense since the economy is in the crapper.

Then we ARE in a bubble, after all?

Yep. And when it bursts it’s going to cost a lot of people a lot of money.  Just like last time.