What’s Next for the Market

The FED indicates it might raise interest rates a quarter point and Mr. Market gets depressed. We have seen these abnormally low rates for so long that investors seem to have lost perspective. Realistically, it is going to take a lot more than a quarter percent raise from here to have any impact our economy. In 2008, the FED had to raise rates to 5.50% before the economy started to cool. In 2000, rates got to 6.75% before the tech bubble popped. The 1990 recession was preceded by rates of over 10%, and the granddaddy of all bubble poppers was Volker’s 1981 peak of 22.5%. Yet now Mr. Market is saying that increase from .5% to .75% is going to tank the economy.

To get back to the 2008 peak at the current rate of increase would take 8.5 years. Even if we double the current rate and move up to a quarter of a point every quarter it would still take almost five years before seeing anything that approaches tight money.

Certainly there is much to worry about. With nothing in the political news likely to help the economy, a lot of conversation topics include overvaluation in the stock market. However, closer examination reveals that much of this overvaluation is concentrated in a small number of very large capitalization stocks. So, it is a bit of over simplification to attribute this overvaluation to the stock market as a whole. In fact, it is still not difficult to find reasonably price companies even though this is not the impression given by the price: earnings ratio of the S&P 500.

Surely, one of the best examples of this is Berkshire Hathaway. At its current price, it offers a very attractive balance between risk and reward. There are others, such as IBM, Fluor, Phillips 66, Core Molding Technologies, and Chicago Bridge and Iron to name a few.

Sentiment Indicators

While sentiment indicators mean very little most of the time, sometimes they can be helpful as a contrary indicator by identifying what is going on in the minds of investors. (Buy when others are nervous, raise cash when the fear goes away).

Investor Sentiment shows only 17% of investors are bullish as May 26, 2016, the lowest level of bullish sentiment since 2009. Short interest on NYSE stocks is currently at all-time highs. A poll of professional investors by "Barron’s" Magazine earlier this year showed institutional investors with the lowest levels on long equity positions since 2012. This is not to say that sentiment indicators should always be taken as an absolute contrary indicator, but my sense is that periods of high bearish sentiment do not coincide with periods of high risk in the market. If everyone is already bearish there is not a lot of fuel left to generate a major decline.

Being no better at predicting the future than anyone else I do not know if the market going to continue up from here, I have been adding a few positions lately based on, of all things, company fundamentals.

This is the first of a series on the physiology of long stock market cycles. Stay tuned for the next exciting chapter.

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