US Stocks Hit All Time High

Bugra Bakan

“The secret of all victory lies in the organization of non-obvious.” Marcus Aurelius (Roman Emperor 161  – 180)

I only discovered Marcus Aurelius in 2000 Ridley Scott movie, Gladiator. I can’t forget the scene, in which to his son Commodus, he says: “Commodus, your faults as a son, is my failure as a father.” He openly and honestly acknowledges Commodus’ shortcomings, doesn’t sugar coat a thing, and accepts full responsibility as a father; my kind of guy. These two characters in the movie are portrayed quite accurately against historical facts. As a philosopher, Marcus Aurelius points out in his quote, to the importance of the non-obvious; the unknown. If you think you’re smart by knowing all the economic facts and you’re ready to invest, think again. All the information available to you (except insider information, which is illegal) is also available to everyone else, and most likely already factored in. The key question is: what might the other investors be anticipating with this information? Because if the known has already been acted upon, the unknown is where the victory lies.

Now, of course this doesn’t diminish the importance of research and collecting data. Even to anticipate others’ actions, you need to know what those actions might be based on. A reaction to certain set of facts, also called a trend, could be identified by looking at historical data and matching similarities to gauge what could be next. This is called a technical analysis, which is always confused with charting. Charting is a small subset of technical analysis, and nowhere near as reliable as trend analysis.

Today’s known and obvious is that the Dow Jones index hit an all-time high, passing the high reached in Oct 2007. The S&P 500 is almost there. What happened, I thought we were going to see a pull back? We will talk about that along with other topics such as other index returns in February and as promised, inflation: what it is, how it is measured and what it all means to you.

Capital markets are giving mixed messages. Because of the lack of conviction, the new all-time high in the Dow Jones index doesn’t excite me all that much. Usually an all-time high is an invitation to join the party and signals an uptrend. This may very well be the case this time, which would be welcome news as I am invested, but I have my doubts.

We are, have been and probably will for a while be in a slow growth environment. Last quarter’s negative Gross Domestic Product (GDP) figure is revised up to 0.01%. This quarter’s GDP is expected to be around 2.5%. The Sequester, as small as it seems, may cut half a percentage point from the GDP, and pull it down to 2% for the first half of the year. The second half performance could be better, but likely below historical averages as well. If so, what is driving the US stock market to an all-time high? 1) Corporate profits 2) Federal Reserve Bank (FED) 3) US consumer’s ever green appetite for goods 4) Everybody else is in worse shape. Markets may be a little bit ahead of the economic reality right now but I won’t argue against making money. Is it a bubble? I have no reason to think so.

One of the important lessons of the Global Financial Crisis and the Great Recession that followed is to not fight against the FED. Invest in the Bernanke and Co. Also invest in the Draghi and Associates, the European Central Bank President, and most recently Japan’s new Prime Minister Abe and Bros. Globally, governments and central banks are committed continuing with their easy money policies and to pushing up the markets. Since unemployment is stubbornly high at 7.7%, and average income isn’t tracking the market gains, who benefits? Corporate profits: previous recoveries came with a drop in the unemployment rate, not this time. Corporations have learned to use technology to their advantage, cut cost, increase productivity and profitability. How long will this party last? Can’t say for corporate profits, but for FED policies: until the unemployment falls to 6.5%, which may take another year or two, if not more.

Speaking of the unemployment rate, there are 6 types: U1, the narrowest definition through U6, most inclusive. The unemployment rate (7.7%) most commonly talked about is U3: the rate of those that are unemployed and looking for a job. It doesn’t include part time workers who would like to work full time, or those discouraged workers who stopped looking for a job. That’s why when the economy starts growing and more people start looking for a job, the U3 unemployment rate can go higher, the devil is always in the details. U6, which includes part time and discouraged employees who stopped looking for a job is currently at 14.3% (Source Bureau of Labor Statistics).

Where was I? Oh, the conflicting messages. So in addition to the separation between the slow economic growth and the market uptrend, the inner workings of the Risk On / Risk Off trade are also confusing. Risk On trade environment is when investors’ risk appetite goes up. The sectors and investments that are sensitive to economic growth and risk appetite are favored in such bull markets, like energy, industrials, metal commodities, technology and consumer discretionary. Notice consumer staples and utilities are not on this list as they are more defensive and typical Risk Off trades. To see Industrials (Risk On) and Utilities (Risk Off) both up at the same time, is conflicting. If you’re not convinced, then how about mid-cap and small-cap stocks outperforming large-cap stocks (Risk On), is accompanied by dividend paying large-cap stocks outperforming all of the above (Risk Off). I can go on and on but I’m sure you got my point: the US stock market is pushing for all-time highs during a sluggish economic growth environment, accompanied by mixed messages from sector performances, and to top it off, unusually stubborn unemployment is in the midst of all-time high corporate profits.

In non-stock investments, a surprise came in the recent downtrend of gold, commodities and bonds. When gold and commodities dip down, this signals deflation (interest rates going down); when bonds lose value, this signals rising interest rates. As you can see, I have reasons to be skeptical. If I am wrong, and the stock market keeps going up, that’s a great problem to have as it is easy to make money in an uptrend. As I have said in my last newsletter, I am not paid to be right; I am paid to make money on my clients’ behalf.

So, if history tells us anything, new highs are followed by a continued up trend and in spite of all the above mentioned confusion, I would happily jump on that wagon. Otherwise, a shallow (5%-10%) correction would be in line with all that I am discussing, and that time would be probably the last chance to get in for this year if you have not already done so.


I wrote about inflation back in May 2012, and not a lot has changed since then or since the Great Recession in 2008. Those who have been following related news will remember the two camps that were set against each other’s thesis; inflation and deflation fronts. The clear winner is the deflation worriers, otherwise known as Ben Bernanke and the FED. They have studied the actions of the FED after the Great Depression earlier in the century, which was to cut money supply too soon and bring the economy back down on its knees. This is no longer a theory on a blackboard. Last quarter, the economy didn’t grow at all as a result of decreased government spending, especially in the military. These are economically vulnerable times.

Back in 2008 (and even now), many people were worried about hyperinflation as the FED has been quite busy printing money. The knee jerk reaction to increased money supply is a rising inflation rate. Inflation is the price increase in goods and services and too much money chasing too few goods pushes prices up. Since the FED has been printing money and increasing money supply, surely prices must be going higher, right? Wrong! Just because dinner is cooked, it doesn’t mean it will be served, and even if it is served, it doesn’t mean we will all rush and fill our plates. What if you’re full? May be this is your third thanks giving dinner and you have no appetite. May be you’re a vegetarian and the only dish served is a big juicy steak. Think of the FED as the cook, banks as the host or the server, and consumers are those sitting around the table. If no one eats the food, it goes back to the fridge, and that is bank vaults.

The result of the supply and demand relation between consumers’ appetite for borrowing and banks’ eagerness to lend is called the velocity of money. This is where we close the circle on the money supply. For some economists, Gross Domestic Product = Money Supply x Velocity. FED’s money printing business results with no lending or borrowing, it’ just food in the kitchen. Because banks have been keeping lending standards tight and consumers have been sitting around not interested in borrowing, too much money is not created and PRICES HAVEN’T GONE UP (much). Current Consumer Price Index (CPI) is up 1.6% from Jan 2012. Velocity is the key concept here and it is triggered by lending.

Some of you will say, how about food and energy prices? The answer: Since Jan 2012, gas prices are down -1.5%, utility prices are down -2.5% and food prices are up 1.6%. Used car and truck prices are down -1.3%. The highest increase came in shelter 2.2%, transportation services 3% and medical services 3.6%. It doesn’t feel that way? Maybe because since 2008, the compounded increase in CPI is 10.94%. (Source: Bureau of Labor Statistics). Now that hurts and I don’t dismiss or downplay it, but it is nothing compared to a 130% increase in stock prices in the same period.  Meaning, if you have been invested, you should have made up much more with your returns on your stock investments. It surely hurts those with no savings or investments, but a discussion of alternative solutions to that problem is beyond the scope of this market letter. Your earning potential should go up with inflation, or more. The biggest hedge against inflation is your earning potential, for those while working. For retirees, a bit more than fixed income investments is needed to keep up, like stocks and commodities.

So, if inflation can turn into hyperinflation, which is a big problem, then why does the FED print money and risk creating it? Because deflation is a much bigger problem to have. You can keep tightening until it works and tame hyperinflation like Volcker did between 1979 and 1987. Deflation’s cure is increasing money supply along with confidence and perception, which relies heavily on the general business and political environment. If prices go down, investors have no reason to bring money to the economy, which pushes prices down, and scares investors away and you end up with a downward spiral.

Long story short, this is why there has been so much money printing globally: to avoid deflation. If you think we have economic problems right now, that’s because we didn’t deal with deflation, which would make our current environment look like a walk in the park. The US economy is recovering, slowly yes but it is growing. Global economic environment is also healthier than 2 years ago. Why is the growth slow? The main reason is that we are also in a period of deleveraging, meaning paying down debt, which would otherwise be funds channeled to production, consumption and investments. Next month I will dive more into this topic, give you some hard numbers and let you decide.

In spite of giving conflicting messages, the stock market is going up, for now. Enjoy it while it lasts. During the last two calendar years, we had a pullback starting in early April. Who knows what’s in the cards this year. Maybe the stock markets are setting the stage for the next secular bull market. We have been so bombarded with bad news since 2008 that possibility seems quite distant now but if you look at capital markets history, it’s always darkest before the dawn.

Next on Shield Wealth Newsletter

Hope you have enjoyed reading my Newsletter. Next month we will discuss the current economic state of the US and its investment implications, which we haven’t done for a while. Please feel free to forward this email to your friends and family and don’t forget to email your questions or comments to: bbakan@shieldwm.com


The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy.

The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.

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