Are we in a new bubble ?

What a start to 2013 its been. The Integrator $50k fund is up almost $40k since the start of the year. The Dow Jones Industrial Average (DJIA) has just crossed 14,000, its highest levels in almost 5 years. You may think I’m excited, but I’m not. In fact, I’m wondering if the market has got carried away. 

 

So the headline across Yahoo Finance yesterday was that “Dow’s Run to 14,000 humbles the worriers”. I don’t know if I am a worrier, but I wasn’t expecting the Dow to climb so high so fast.

The DJIA is up almost 7% since the start of the end of 2012 from about 13,100. If you had asked me at the beginning of the year for what I believe the DJIA could return, I would have told you that it would have been around 10% for 2013. So we are more than 2/3 of the way to my 2013 prediction, in just a little more than the first month of the year.

What’s driving the surge?

Overcoming the fiscal cliff  - I think the initial joy of getting over the fiscal cliff hump gave the markets a welcome boost. Markets hate uncertainty, and you can argue that the situation of uncertainty about when and how the fiscal cliff situation would be resolved articificially depressed markets somewhat last year.

Employment chugging along – The employment numbers that have been coming out the last few months have been good.  A total 157,000 jobs were added in January, which is close to the levels needed to start making some inroads into unemployment. Jobs numbers will have to be eventually increase more than this to actually bring down the unemployment rate significantly

Reasonable corporate earnings. Reported corporate earnings to date have been reasonably good. Many of the DJIA heavy weights exceeded earnings expectations including Exxon, Merck, Boeing and Pfizer as well as as host of other companies, helping to push up the DJIA.

Welcome back to the small investor!  There is also some suggestion that after years of having their money parked on the sidelines in bonds and in cash that small investors are starting to make their way back into the market. When I start hearing arguments like this this one, that starts to send bubble smoke signals to me. Time will tell whether we see a surge of new money flows pouring into equity funds from cash to confirm if this is the case.

The market certainly isn’t in bubble territory from my perspective when valuations are considered. Its currently trading at a PE ratio of 15.3 X  historical earnings. The average trailing PE for the Dow since 1929 is  about 15.5x earnings, which places the DOW at around fair value. This suggests to me that there is scope for the market to continue to advance,  without valuations necessarily blowing out. However I don’t believe the pace of this advance to date is necessarily sustainable.

Clouds on the horizon?

Throughout much of last year, the situation in Europe was fairly grim. Chronic debt problems in Spain, Greece, Portugal and Italy had the market in a confused state for much of 2012. There was also extreme volatility present.

I’m not sure that any of the Europe problems have gone away, they’ve merely been “parked” with the focus on the fiscal cliff discussions and US Corporate earnings. In fact European earnings have been reasonably weak in the current reporting season with many large corporate incude Deutsche Bank, Astra Zeneca and Shell all reporting weak earnings.  If a spate of bad news starts pouring out of Europe then that could send the US markets back.

Technicals?

As a fundamental investor who’s happy to take a 40 + year view on the market, I’m lucky that I don’t have to focus too much on whether the Dow is 13,500 or 14,000. I figure that when the Dow eventually hits 30,000 at some point, a market entry at 13,500 or 14,000 won’t make too much difference.

That said, if I can look to invest at a time when stocks are generally cheaper, of course thats what I’ll look to do, Some people look at technical indictors to work out whether the market is overvalued or undervalued. I don’t know much about technicals and have never looked at starting a position based on what the technicals say. I had a chance to review a book focussed on technical indicators thanks to one of the readers of the blog.

Lets be honest about trading provides a broad overview of trading strategies and successful techniques that traders have used. I suspect that if I had a better background knowledge of trading I may have got more out of the trading specific techniques that were discussed in the book.

The most interesting part of the book to me was a chapter in the book that dealt with determining whether markets are in a bubble. For the Nasdaq, the book suggests a possible “index” bubble occurs when leaders of the bubble have “popped” (look at Apples major descent down in the last few weeks) while some of the previous “pigs” or neglected stocks soar (notice the dramatic upward price moves of RIM, Facebook and Netflix in recent weeks).

Fortunately, with my investing strategy I dont need to have worry about picking the peaks, and I believe that the market is about fairly valued based on historic multiples, but the book provided some very interesting food for thought.

What am I doing now?

I was able to deploy some capital in several new positions at the beginning of the year in CME, NVS and BP . CME and NVS are up close to 8% and 6% respectively, in under 1 month. I was hoping to add to those positions in a pullback, though it looks like I may not get a chance to that for at least a little while.

I am looking to add some additional capital into dividend stocks over the course of the year, but I think given the rapid nature of the market rise, I’m content to sit tight for a little while and wait for an opportunity to add some money once concerns about Europe emerge again (and they surely will!).

And for the record, I still believe we will end the year with the DJIA up about 10%, or at 14400 or there about!

 

Comments

  1. It’s hard to tell if we’re in a bubble or if this is simply the rally that should have happened months or years ago. I’m going to keep on investing regardless of what happens. I just have to get past the sticker shock of the rising prices.

    • Integrator says:

      I think we are probably fair value at the moment, but if the pace of the rally continues at this rate, we may be soon entering the overvaluation range in my opinion. Again, if you have a long term view, this recent rise is probably immaterial.

  2. I look at the 10-year yield. If it hits 2% or higher, I’m wary and start to trim stocks.

    • Integrator says:

      Sam,

      Equity risk premium is a great way to look at overvaluation as well in my opinion (which is effectively what expected long term stock returns less long dated bonds (like the 10 year) gives you. Based on those measures, I believe we are still in line with historical averages at this stage.

  3. I’ve been looking for a pullback to buy as well….

    • Integrator says:

      Thanks for swinging by Marie. I believe we are due for a pullback as well, but I think there is still an inflow of money chasing some of the gains that people have missed in the last few weeks.

    • Same here, Marie. I have another $1000 to put in a 2012 IRA, and since we have until April to do it, I keep waiting for a dip. Maybe when the debt ceiling talks heat up we’ll see one?

  4. I simply continue to buy great businesses at a discount to their intrinsic value. So simple and stress free. I will take this opportunity to make a couple trades by selling options.

    • Additionally I believe bonds are in a huge bubble. I personally cannot wait for it to pop because anything with the word “Bond” attached to it is going to get absolutely slaughtered and that is when I will take a considerable amount of my cash and purchase municipal bonds.

    • Integrator says:

      I can imagine you’ve been making a small fortune selling put options recently!. Its something I’ve been actively thinking about as well.

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