Join TSR now and get all your career questions answeredSign up now
    • Thread Starter
    Offline

    2
    ReputationRep:
    Certainly not, in my view.

    As many of you know last Tuesday the Dow quickly passed its previous all-time high of 14,164.53, which was set in late 2007 before the U.S. entered a recession. The S&P is also set to rally past its previous high aswell.

    However, does anyones else look at this market and feel the rally is completely unjustified? The underlying fundamental economics are still relatively weak (although improving) and although corporate earnings coming out of the states are certainly improving it is certainly not the impetus for equities to be hitting all time highs.

    The only thing driving this bull market is the excessive liquidity coming from QE, and QE is certainly not sustainable. The FED has been digging itself into a deep hole. It cannot maintain QE forever, it cannot keep rates this low because it then faces the question of double digit inflation (which at the end of the day is probably what they are indirectly wanting to achieve, decreasing the nominal value of their debt etc.) and the only way to tackle inflation is to tighten their monetary stance - hiking IR's, tightening QE - and depending where we are on the cycle, we are more or less back to square 1. The thing is the economic fundamentals are not strong and so a reversing of the FED and other Central Bank's Policies could pull the economie(s) back into recessionary terms.

    This leaves me with the sense that Equities are overvalued and are also a very risky asset class to hold going forward (who the hell can foresee when the FED pulls the plug and says that is enough?)

    What would people say are the real indicators to look out for as to when QE , etc., could be halted? Inflation? Mortgage rates?

    Would be interesting to hear your views.
    Offline

    0
    ReputationRep:
    (Original post by Hackett)
    Certainly not, in my view.

    As many of you know last Tuesday the Dow quickly passed its previous all-time high of 14,164.53, which was set in late 2007 before the U.S. entered a recession. The S&P is also set to rally past its previous high aswell.

    However, does anyones else look at this market and feel the rally is completely unjustified? The underlying fundamental economics are still relatively weak (although improving) and although corporate earnings coming out of the states are certainly improving it is certainly not the impetus for equities to be hitting all time highs.

    The only thing driving this bull market is the excessive liquidity coming from QE, and QE is certainly not sustainable. The FED has been digging itself into a deep hole. It cannot maintain QE forever, it cannot keep rates this low because it then faces the question of double digit inflation (which at the end of the day is probably what they are indirectly wanting to achieve, decreasing the nominal value of their debt etc.) and the only way to tackle inflation is to tighten their monetary stance - hiking IR's, tightening QE - and depending where we are on the cycle, we are more or less back to square 1. The thing is the economic fundamentals are not strong and so a reversing of the FED and other Central Bank's Policies could pull the economie(s) back into recessionary terms.

    This leaves me with the sense that Equities are overvalued and are also a very risky asset class to hold going forward (who the hell can foresee when the FED pulls the plug and says that is enough?)

    What would people say are the real indicators to look out for as to when QE , etc., could be halted? Inflation? Mortgage rates?

    Would be interesting to hear your views.
    I think your thoughts about QE is largely correct, it's obviously unsustainable, but that doesn't mean it's without purpose. It's a means of getting out of a zero lower bound in certain markets, and as long as it's enough to tide the economy over until a time at which fundamentals are stronger, then it's serving a worthy purpose.

    I don't think that most of the current high can be explained by fundamentals, I think it has more to do with declining risk premia attached to equity markets, caused in no small part by the belief that QE will continue. The obvious thought is that when QE stops, the market collapses. But I think there's good reason to be sceptical of that view. For one, some measures of fundamentals are improving, see Gavyne Davies' most recent FT article where there's a nice chart showing the rise of US corporate profits as a share of nominal GDP. I think there's probably a link between this measure and the rise of equity prices, but I think the claim that profits/GDP explains as much of the equity price rise as that chart suggests is a bit shaky.

    I think there's good reason to think that a correction will occur when QE does end, but I don't think it'll end this year, surely the Fed can see it's too early to pull the plug? Further, I'm not convinced the correction will be as severe as some people make out. If fundamentals recover, and the US (and other states, for that matter) are able to issue credible plans to deal with their debt (perhaps there's a necessary link between recovering fundamentals and this), then I can't see why the correction wouldn't be modest.

    Finally, to borrow from the same FT article, even if you take away QE, a modest premium on earnings yields from equities would exist over long-term yields on treasuries. Putting it this way, equities look cheap relative to govt credit (and even corporate credit if you buy into the story that it's increasingly overbought).
    Offline

    0
    ReputationRep:
    (Original post by Hackett)
    What would people say are the real indicators to look out for as to when QE , etc., could be halted? Inflation? Mortgage rates?
    Those, as well as consumer indexes/consumption/production/labour market measures. I'd expect all fundamentals to increase some more before it ends.
    Offline

    1
    ReputationRep:
    On your last question of when QE/low rates will stop, I believe that the Fed has given pretty clear guidance on this, I don't really follow this too closely but I believe beyond 2014. The theory being that once you reach the zero bound you have to give verbal guidance that you are going to stay there with above target inflation and until unemployment goes down (if your the Fed).

    On your main question, what would justify this level? Generally, there has been improvement and the stock market isn't really connected with any broad stuff like GDP, although the latter stuff is interesting.

    Another point, is that you seem to imply that growth is never going to improve...it isn't the case that the Fed is stuck between causing a recession and continuing QE. There is some repairing of balance sheets going on which will eventually improve things more (i.e. the construction jobs added in recent NFP) and unemployment is falling. They don't want to create double-digit inflation either.

    I think the reality of the situation is demonstrated by M2 velocity, it is at all-time lows...which implies that QE is something of an irrelevance, or at least the actual effects of QE are really not understood. The UK is perhaps a better example of this though. Either way, QE appears to have been largely a tool to fill a hole in bank balance sheets and as the Fed seem to be planning to hold USTs to maturity nothing will really happen when they stop. However, if all the money at the Fed (for some strange reason, maybe deregulation) gets deployed at once then that might be a problem. It is a bigger issue for credit than equities anyway.

    Having said that, margins for US-listed companies are at all-time highs which will revert (the relation between corporate profits/GDP is also ****ed as well, therefore) and it is very difficult to find any companies trading at interesting levels (esp above $1bn). People seem to mention corporate balance sheets but companies seem to be buying back stock rather than doing anything useful and this is often accompanied by issuing huge amounts of debt too (I think US investors/managers are suffering from severe short-termism). Equities are cheap relative to credit, as the latter is massively overvalued that really isn't saying much.

    One good source on all this is GMO and Howard Marks from Oaktree (who writes on credit a lot). My conclusion, fwiw, is that equities are a bit high but it really isn't very severe. The multiple isn't crazy but there are far better opportunities elsewhere i.e. Europe. It is too early to be thinking about what will happen with QE ending but it is worth recognizing that credit markets are badly distorted which may affect companies who issued too much debt (as far as I can tell, there are quite a few).

    http://research.stlouisfed.org/fred2...ax_630_378.png

    http://research.stlouisfed.org/fred2...ax_630_378.png

    http://static3.businessinsider.com/i...X=620&maxY=464
    • Thread Starter
    Offline

    2
    ReputationRep:
    Some very interesting points raised by both, I don't think there is alot to disagree with there.

    There is certainly no doubt that Equities look cheap vs. credit, and as the sell - side keep putting "the great rotation to equities" could certainly and most likely occur. European equities are cheaper than EVERY US sector and general consensus here is that European Equities are looking like a good buy for 2013.

    I can't help but look at this chart below though and think that as soon as the FED pulls QE and hikes rates that the Dow will be trading back to 2008 levels. The rally between 2000 and 08 was driven by excessive credit and rates not being 'properly' priced in to where the economy was at and then you look at what has driven this recent rally, QE, and QE has to stop somewhere. Yes, underlying economic conditions may certainly improve but as we all know this whole thing is cyclical. I guess I'm just trying to call the timing for this one ha

    Name:  united-states-stock-market.png
Views: 72
Size:  18.2 KB

    I would also reccommend taking a look at this piece:

    http://www.edelweissjournal.com/pdfs...ournal-012.pdf
    Offline

    1
    ReputationRep:
    (Original post by Hackett)
    Some very interesting points raised by both, I don't think there is alot to disagree with there.

    There is certainly no doubt that Equities look cheap vs. credit, and as the sell - side keep putting "the great rotation to equities" could certainly and most likely occur. European equities are cheaper than EVERY US sector and general consensus here is that European Equities are looking like a good buy for 2013.

    I can't help but look at this chart below though and think that as soon as the FED pulls QE and hikes rates that the Dow will be trading back to 2008 levels. The rally between 2000 and 08 was driven by excessive credit and rates not being 'properly' priced in to where the economy was at and then you look at what has driven this recent rally, QE, and QE has to stop somewhere. Yes, underlying economic conditions may certainly improve but as we all know this whole thing is cyclical. I guess I'm just trying to call the timing for this one ha

    Name:  united-states-stock-market.png
Views: 72
Size:  18.2 KB

    I would also reccommend taking a look at this piece:

    http://www.edelweissjournal.com/pdfs...ournal-012.pdf
    I had a long post but I will try and summarize. For most non-financials QE doesn't mean anything. Earnings are up 25% since trough and have almost doubled trough-on-trough (2001/2009). Credit growth might have driven the US economy but that doesn't mean anything for the stockmarket (the '08 "crash was scary but irrelevant for most businesses). In terms of right now, there is a difference between not buying and going short. To justify your argument you have to say why SP earnings are going to fall significantly (as P/E is certainly not as high as before). QE is a problem for credit but for most businesses this means nothing. It isn't that economies are crashing, it is that they are not growing. QE is related to this but should be seen within a context of a host of other global factors. Again, I don't like the stock market here; QE may have pushed prices and profit margins are too high. I think, from here, it won't get much better but it is not going to get significantly worse, esp. as (although valuations are affected) actual fundamental value won't change.

    https://www.gmo.com/Europe/CMSAttach...ChyBBvdvpD4%3d
 
 
 
Poll
If you won £30,000, which of these would you spend it on?
Useful resources

Articles:

Guide to investment bankingGuide to consultancy

Featured recruiter profiles:

Deutsche Bank logo

Deutsche Bank is recruiting

"Thrive in an international banking environment"

Quick link:

Unanswered investment banking and consultancy threads

Groups associated with this forum:

View associated groups

The Student Room, Get Revising and Marked by Teachers are trading names of The Student Room Group Ltd.

Register Number: 04666380 (England and Wales), VAT No. 806 8067 22 Registered Office: International House, Queens Road, Brighton, BN1 3XE

Quick reply
Reputation gems: You get these gems as you gain rep from other members for making good contributions and giving helpful advice.