When the market breaks out to all-time highs, as it has today, your most important task is to play the skeptic, to don the bear suit, to poke holes. It's not to cheerlead, sing praises or marvel. You don't defend a market at new highs, that's what you do when you the market gets clubbed like it was just a few weeks ago, with the averages down more than 5% and 50% of the S&P 500 off by 10% or more.
So let's take this opportunity to go over the bear case, the reasons why the market shouldn't be this high in the same way that the market shouldn't have been so low earlier in the year.
First is valuation. There's no doubt that the market is stretching the bounds of prices. Stocks are selling at 17x earnings and that's simply not cheap. So why can it go higher? Because I think that earnings estimates are going higher, not lower, and that means the stock market may not be as expensive as we think it is. Profits are robust, as are dividends and buybacks. Stocks are still bargains compared to bonds, and new Fed Chair Janet Yellen is telling you not to fight the Fed, which still favors lower interest rates.
Second is the level of optimism. Isn't it out of control? Let's remember that all we have done is gotten back to slightly more than even from the end of the year, which isn't that much given that there's been so much that's good since the beginning of this year. The Dow is still in the red. That's a good sign, not a bad one.
The market has been climbing a wall of worry, but the wall's become less barbed, with fewer machine guns facing it. Notably, there's a remarkable end to lots of partisan bickering, whether it be the termination of government shutdown attempts or another wrangling on the debt ceiling, both of which contributed mightily to the decline in earlier in the year. The decline of Washington's influence on Wall Street is the story of the year, and it's almost entirely a 2014 story. As I say right up front in Get Rich Carefully, Washington's been the cause of every 5% decline in the last three years, and it has disappeared as a negative.
Yes, the market seems to be dismissing the violence in the Ukraine, but it took a wallop on the crises in Turkey, Argentina and other emerging markets.
And it isn't as if the market is ignoring the negatives. Have you looked at the collapse in retail values? This group has been positively leveled, mercilessly, and the biggest companies are the worst performers -- outfits like Wal-Mart (WMT) and Target (TGT). No one's giving these companies a weather pass. Some of these stocks have been obliterated. Others, like Starbucks (SBUX) and Whole Foods (WFM), are fantastic operators but they haven't kept pace. Best Buy (BBY), GameStop (GME), Conns (CONN), standouts last year, have been laid to waste. Lululemon (LULU) is now valued as a half a pair of stink pants.
The bank stocks need interest rates to be higher, so they aren't cooperating with the rally. The insurance stocks, among the biggest winners last year, have been miserable. That's a sign of skepticism as the financials are the biggest sector in the whole market.
Autos, market leaders last year, have been just awful. So have the big consumer-product stocks. They have been an anchor to leeward since 2014 began. They are really head-scratchers and a sign of outright bearishness, not unlike retail.
Anything that touches China can't catch a break at all. Mining and minerals? Forget about it -- and it wasn't until today that the oils finally took off.
Third, we hear that many stocks are levitating without a basis in fact. I totally get this, but the dramatic level of mergers and activist activity say otherwise. Is Comcast (CMCSA), parent company of CNBC, a dumb acquirer? I think it's been incredibly shrewd over the years, and the Time Warner Cable (TWC) deal only confirms that. The Actavis (ACT) deal for Forest Labs (FRX), like many others, sent both stocks flying. Just today, the higher bid from Men's Wearhouse (MW) for Jos. A. Bank (JOSA) moves both stocks up, as does the TriQuint (TQNT)-RF Micro (RFMD) merger as it creates a worthy competitor to Skyworks Solutions (SWKS) for the cellphone industry. Companies are worth more to other companies than to the market, and that's a sign of undervaluation, not over valuation.
Many of these mergers come after shareholder activism jangled the people at TriQuint into action. We are seeing the same thing at Darden (DRI), the parent of Red Lobster and Olive Garden; with Carl Icahn at Apple (AAPL) and now eBay (EBAY); even Microsoft (MSFT) and ValueAct, and PepsiCo (PEP) and Mondelez (MDLZ) with Nelson Peltz. This is an unprecedented time for shareholder activism, and boards are responding by either shrinking to grow, giving you sums of the parts that exceed the company's value, or just selling outright.
Fourth, the funny money of the old days -- the dreaded year 2000, when stocks were valued by eyeballs and mindshare -- is again upon us with the Facebook (FB) acquisition of WhatsApp and the Twitter (TWTR) rally to valuation levels that make no sense at all, and Yelp (YELP) is out of control. Tesla (TSLA)? How can that be valued? Netflix (NFLX) goes higher for paying more to Comcast? Amazon (AMZN) keeps losing money and few seem to care?
What can I say? There's some truth here; in fact, this is the most worrisome part of the market because once you go down the path of trying to explain values of uber-expensive stocks vs. other uber-expensive stocks, you are playing with fire. Some momentum names are simply overheated, and they bother me every day. But I have made my peace with them as the price of performance. You need some octane to keep up with the averages, which is why my charitable trust owns both Facebook and Google (GOOG), but at least the latter's cheap on the outyears. But high octane is explosive in a bad way.
Let's not forget there's a whole other element of tech, by the way, that is valued miserably -- Hewlett-Packard (HPQ), IBM (IBM), Intel (INTC), Microsoft and Cisco (CSCO), for instance. They fell behind in social, mobile, the cloud and connectivity, so they aren't going anywhere, deservedly so. And I say you can't buy them until they come down a bit.
We are dramatically overbought. The S&P oscillator that I follow clocks in at plus 9 -- the most overheated the market's been in years. Anything above plus 5 is dangerous, and historically, a terrible level to do any buying. Again, I am not denying discomfort. It's just plain worrisome, which is why the charitable trust is scaling out from what we bought at the lows and not piling in.
Finally, the biggest worry of all. We've had two straight months of bad employment numbers. As I write in Get Rich Carefully, that should not, and cannot, be dismissed. The market is banking on these numbers being understated because of the weather. Bulls should hope so.
The meager employment gains keep the Fed on the friendly side. Still, the employment issue, the overbought market and the wampum-silly money Nasdaq 2000 elements are very disconcerting. Undeniable.
So where do I come out? Pretty mixed, actually. I believe that the market is too elevated given the punk employment number, the overbought nature of the averages and the cultish nature of some parts of the Nasdaq. But stocks remain the best game in town, and that's undeniable.
The bottom line is this: There are values, but as we go higher, there are fewer of them. Worrisome? How about still bullish -- but undeniably not as good as it was at lower levels. Sorry to be a tad cautious, but buying low and selling high is a better mantra than buying high and hoping to sell higher.