Wall Street vs. leading indicators: a worrisome disconnect

24 Jun

To anyone paying close attention to our nation’s financial situation, one of the unmistakable patterns that seems to be developing in the last year or so is that stocks keep heading up while the leading financial indicators remain comparatively uninspiring.

Needless to say, any time we see the markets booming despite underlying fundamentals that seem more worrisome and arguably don’t justify those heights, we start to worry about a bubble. Investors don’t seem to recognize (or at least their behavior doesn’t seem to reflect the fact) that profit margins are more than 70% above their historical norm. Profits are rising at the same time that revenues are actually falling, a strong sign that the current trend is not sustainable. And with historic and possibly even unsustainable fiscal deficits in both government and household savings, the stage seems set for a letdown. And if you have a lot of money tied up in the stock market, that letdown could be a costly one.

While some predictions suggest that we may be in store for some mildly disappointing earnings in the coming quarters/years, others are more dire, forecasting an annual contraction of around 10% for the next few years.

There’s no doubt that some of that pessimism (or, as I would argue, realism) is influenced by ongoing worries about the policy of Quantitative Easing that the Fed has been pursuing for some time now. This has created an ocean of virtually 0% interest money out there. At some point, printing money is going to backfire. The bottom line is that stocks are not cheap, but they may be overvalued. At the same time, artificially inflated profit margins have helped to create the illusion that the value of those stocks is reasonable. This is the very definition of a bubble. Investors—especially those approaching retirement—would be wise to think hard about the difference between real value or surface value, and to factor those considerations into their retirement planning.

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