A Warning for Stock Bulls: Leverage Works Both Ways – March 7, 2014

Here’s the news of the week – and how we see it here at McAlvany Wealth Management

A Warning for Stock Bulls: Leverage Works Both Ways

Not much changed this week – insanity still reigns. Stocks are stuck in “melt-up” mode, sporting a host of bubble-like valuations thanks to a steady stream of opaque economic data and the resultant chatter regarding prospects of further tapering by the Fed. A stronger euro forced the dollar index into sub-80 territory on the chart. Both the ECB and BoE decided to stand pat on interest rates following an uptick in eurozone inflation, retail sales, and production in January. European stock markets tanked anyway in overnight trade Thursday – a reaction that proves Europeans (unlike Americans) are keenly aware that there’s now no such thing as a “self-sustaining” economy without stimulus.

MWM 14, 3-7 Box ScoresUS Treasury prices slipped, not only in response to stronger US equity prices, but also on increased Fed tapering speculation – given the too-good-to-be-true jobs report (175,000 jobs created vs. 149,000 expected) released on Friday. The precious metals traveled sideways, perhaps biding their time ahead of an eventual break in the leveraged momentum at work in stocks (NYSE margin debt reached an all-time high of $451.3 billion, up $6.0 billion in January).

Obama submitted his new $3.9 trillion budget proposal that, thankfully, was deemed DOA by both Republicans and Democrats. The plan called for a 6.8% increase in spending, $1.0 trillion in new taxes, and assumed an economic growth rate of 3.0% annually through 2017. But the plan was rather duplicitous on the subject of how these new taxes would be levied. It was advertised as requiring the wealthy to bear the burden, but details of the plan revealed the presence of tax loopholes described as “carried interest” designed to do the opposite. Among those that stood to benefit from the loophole were hedge fund managers. At last read, the top 25 hedge fund managers earn a cool $1.0 billion per year on average. In any case, it’s inconclusive as to whether the Administration believed the proposals would be taken seriously or whether it was simply political propaganda ahead of congressional elections in November. But whatever Obama’s reasons, those in the middle class might want to pay closer attention in the future; the proposed tax increase was aimed at them.

Next week, we might hear from a few companies in the form of 1st quarter pre-announcements. We expect these to be soft, but, whatever the outcome, stocks at present lofty valuations bear a hefty burden of proof. And let’s not forget that the Fed may also be inclined to continue tapering in the short run, for a variety of reasons. For one, it believes the US economy to be growing (if not for that nasty weather). And second, there’s always a chance that cooling the speculation in stocks would rotate expended stimulus funds back into bonds – where lower rates are desperately desired. The Fed hasn’t seen lower rates as a result of its actions (both monetary and regulatory) for over nine months now – so we wouldn’t put it past them to make noises aimed at scaring money out of equities into bonds.

Best regards,

David Burgess
VP Investment Management
MWM LLLP

2014-09-26T16:39:33+00:00