Stock and commodity markets have seen a dramatic bounce the past month. As we survey the charts this morning we are clearly approaching another interim test as several indices flirt with overhead resistance. This has been a question of some buying the rumour of QE2 coming. One obvious risk here is that it doesn't. (There is much public disagreement on QE2 merits.) Another risk is that it does happen, but those who bought the rumour will also be quick to sell the news.
Markets today are hyped up on speculation rather than compelling growth prospects. That said if there is sufficient follow-through and some sectors and indices do manage to break out over the next couple of weeks, tactical investors may well get some cautious buys. Bulls will taunt that investors should not fight the tape. A more useful and intelligent statement is that investors should stay true to their own rule set. If we get buys on our rules we should buy. But only where we also have our sights clearly focused on our pre-defined exit rules as well. On most objective criteria, over the medium term there appear to be mostly downside risks from current prices. As Money Manager John Hussman points out cogently in his excellent weekly letter today, allowing for the possibility of further short-term gains, in the medium term, valuation metrics today are at levels likely to end in more investor losses ahead:
“…but at least for now, investors evidently could not care less. Had investors been correct in ignoring the ultimately disastrous risks of the dot-com bubble, the tech bubble, the housing bubble, and the overleveraging of U.S. financial institutions that preceded the recent credit crisis, we would concede that the market's wisdom on these issues should take precedence over our own concerns. But in our view, those disasters were predictable. Likewise, as noted above, the persistent willingness of investors to misprice stocks is exactly why they have gone nowhere for over a decade. We'd love to be bulls, scampering happily about. But that would be helped if stocks were priced appropriately and if there was not a large anvil suspended on a fraying string overhead.
We strongly believe that price and volume behavior conveys information, but that belief does not extend to the dogma that they do so perfectly, or that prices are “sufficient statistics” for the overall state of the world (which would make analyzing additional data useless). Rather, our view is that the stock market is substantially overvalued here, and that investors continue to be diverted from the big picture by the clown carnival of short-term news and investing-as-sport that is celebrated on financial television. “