The rise in U.S. stocks to new records should not be seen as an indication of underlying economic health, but the byproduct of central banks that keep pumping money into the global financial system.
That’s the warning from Michael Lewitt, an investment adviser and editor of The Credit Strategist newsletter who correctly forecast the financial crisis of 2008. He recommends a cautious approach to stocks going into 2015.
“The U.S. stock market is overvalued both in terms of current corporate earnings as well as the economy’s potential future growth,” Lewitt writes in his December issue. “Investors would be wise to hedge their portfolios both to protect their gains and defend against systemic instabilities that are increasing.”
The S&P 500’s valuation has risen 60 percent in the past three years to trade at 17 times forward earnings per share, a high valuation that “would be less worrisome were it supported by strong organic growth, but this one is not,” he says. Stocks are getting a lift from dividend payments and corporate buybacks while companies devote less money to investing for future growth.
Meanwhile, Lewitt says investors are chasing assets that have been boosted by record levels of monetary stimulus as central banks pumps trillions of dollars into the global economy to boost growth.
"Rising stock prices may appear to reflect improving corporate earnings and economic fundamentals, but that is a misreading of what is happening," Lewitt writes. Rising asset prices reflect "another phase in the demise of fiat currencies and the stability of the global monetary system." A fiat currency is backed by a government, not a commodity like gold.
The Bank of Japan last month decided to continue growing its monetary base by $683 billion a year, and the European Central Bank is expected to begin buying billions of dollars in debt of European countries next year. The Federal Reserve in October completed its third round of bond-buying, a stimulus program known as “quantitative easing,” after increasing its asset holdings to $4.5 trillion from about $1 trillion in 2008.
“Stock prices will likely keep rising until these policies and their consequences are understood for what they truly are by enough investors to shake market confidence,” he says. “Pinpointing when that will happen is extremely difficult.”
Japan’s effort to lift its economy out of the fourth recession in six years by devaluing the yen is a key risk to global financial stability, Lewitt says. Japan has high debt and an aging population leaving the work force, while neighboring countries face pressures to devalue their currencies to remain competitive.
“Japan is demonstrating what the terminal phase of central banking looks like,” he says. “Unfortunately, the rest of the world is going to be left picking up the pieces after the terminal phase fails.”
The monetary stimulus by Japan and Europe may lead the Federal Reserve to raise interest rates more slowly, says Nouriel Roubini, an economist at New York University.
“If global growth remains weak and the dollar becomes too strong, even the Fed may decide to raise interest rates later and more slowly to avoid excessive dollar appreciation," he writes in an article for Project Syndicate.
“The recent decision by the Bank of Japan to increase the scope of its quantitative easing is a signal that another round of currency wars may be under way,” Roubini says. “Central banks in China, South Korea, Taiwan, Singapore, and Thailand, fearful of losing competitiveness relative to Japan, are easing their own monetary policies, or will soon ease more.”
© 2022 Newsmax Finance. All rights reserved.