No Worries in Stock Market? Not Quite
If you were dropped from a spaceship today and told to evaluate the investing landscape in the United States, you would smile.
After all, earnings are coming in fairly strong, rates on 10-year Treasuries are historically low, and real rates (rates after deducting for inflation) are below 2%. All of this would support higher stock prices.
However, if after landing you picked up a newspaper and read a bit deeper into the current state of the world economy and its looming issues, you might want to get back on that spaceship and fly away.
When you combine the current macro-economic events and potential negative events, that smile will quickly turn to a potential frown. Among those events: potential economic disaster occurring in Europe, which will undoubtedly be a systemic problem around the world; the debasing of our currency while we are in the middle of a race to the bottom with other countries; run-away debt where our country will soon resemble Greece; potential war breaking out in the Middle East; and soon-to-be-seen runaway inflation.
Professional money managers are ignoring these events and focusing solely on the rosy landscape. They are paid based on what they do quarter by quarter. However, individual investors need to be cautious. Enjoy the recent move up -- but after 25 years investing money for wealthy individuals, one thing I have learned is that there is usually a reversion back to reality at some point.
Absent of any of the stated negative events occurring, which will quickly hurt forecasted earnings, I believe that inflection point will begin when we see the 10-year Treasury start to rise. This data point is how portfolio managers value the market. Right now, with rates so low, they assign a higher acceptable price-earnings multiple to the market. That acceptable P/E ratio is 16.25. However, when rates on the 10-year Treasury rise 200 basis points, that acceptable P/E ratio will drop to about 13.75.
What that means to you is troubling. Basically, if all remains the same and stock prices don't move at all -- but interest rates on the 10-year jump up -- stocks will quickly become 20% more expensive.
Interest rates start moving higher as we see inflation in the economy. I see inflationary pressures growing every day, and I am sure you do, too. Be careful, and I recommend starting to reduce exposure to stocks.
Ed Butowsky is an internationally recognized wealth manager. His upcoming book titled "Are You Committing Financial Suicide?" is expected to be released this spring.