Smoke and Mirrors

"It isn't so much that hard times are coming; the change observed is mostly soft times going." - Groucho Marx

All eyes are on the United States debt ceiling debate.  This is just smoke and mirrors.  If anyone out there really thinks that the United States will not raise the debt ceiling in time to stave off a default then they must be from another planet.  No United States congressman or senator would throw their political career in the toilet by forcing a default.  It is not going to happen.  Not yet anyway.  Whether the compromise will be enough to calm the jitters of the market is another debate entirely but for now all this smoke is covering up the real problems scattered around the globe.

I have discussed Europe in my previous blogs, but it is becoming abundantly clear that the only way forward in Europe is a dramatic write-down of sovereign debt.  This will cripple the German, French and Swiss banks and could set off another round of financial contagion.  To be honest I do not see any other way out and the longer that the European leaders dither about the solution the more pronounced the fallout.  To me this is a time bomb that will explode at the worst possible moment.

The next major issue is China.  Growth there is slowing at an alarming pace and it appears that the real estate bubble in China has finally burst.  Banks are now scrambling to remain solvent and this is feeding into the economy in general.  There are reports that manufacturers are unable to fill orders as they cannot access the money previously promised from bank lines of credit.  As China is or was the only bastion of hope in the globe this is big news.  Watch out if it gets worse as those sovereign Chinese investments will need to be repatriated to help offset some of the problems on mainland China.

The United States stock market appears to be overvalued.  I know that based on historic levels of price to earnings ratios it is low, but when you compare the current price to earnings ratio in a low interest rate environment, the valuation metric is actually high.  A "normalizing" of the price to earnings ratio extrapolates to roughly 20 from the benign level being reported of 13 and this is worrisome.  Particularly when you match this against the high levels of earnings.

Company earnings are extremely high.  This is a factor of many things but two major causes of this are the unlocking of working capital as a result of slower growth and the low interest rate environment which is throwing billions of dollars down to company bottom lines.  This is not sustainable and therefore I expect that going forward company earnings will slow dramatically.  This will have the negative effect of increasing the current price to earnings ratio further and will show that the market is overvalued and due for a correction.

Another signal is that company insiders are selling stock of their own companies at an alarming rate.  The latest report is that sellers outnumber buyers by 7,900 to one.  Not surprisingly this is an all time high and does not bode well for the future.  If anyone knows about the future of a company earnings and its prospects it is the insider.

The final issue for the market is that it is now being almost exclusively driven by the high frequency traders.  These companies buy and sell millions of shares so fast that they are occurring our in cyberspace.  Stocks cross so fast that the computers running the markets are unable to capture these trades which are therefore occurring unregistered in cyberspace.  If and when all of these traders head in one direction watch out below.  Combine this with weak underlying fundamentals as described above and you have a situation that could make the flash crash seem mild.

Economic weakness persists in the United States.  It was recently reported that temporary employees are now at a higher percentage of total workers than during the great depression.  A lot of this could be attributable to a change in the style of work but certainly not a statistic that points to strong consumer spending in the near term.  Housing is stuck in the doldrums and recent changes to the laws have increased the number of strategic walkouts.  These are people that decide not to keep the extra house or the investment property because it is a drain on cash flows so they just walk from the property and stop paying the bills even if they can manage to afford it.  This strategy is effective in wiping out debt to the homeowner but will keep the price of properties depressed for years to come.

I am afraid that I do not see any silver lining at present and as such I cannot recommend investing anywhere else other than in cash or if you have the stomach for volatility then you can try gold or silver.  Once in cash research my company on http://www.fixedratedeposits.com/ and earn a decent return on that cash while waiting for something to change for the better.