The State of the American Economy III

At the office, my investor buddies remain glued to their computers and televisions, watching CNBC all day and rubbing their hands greedily as they watch the Dow Jones Average cruse to record highs.

However...

Kumogakure isn't so giddy. As a matter of fact, I have moved my funds to a very defensive posture of bonds, cash, and overseas investments.

(Disclaimer: Please understand that this is not intended to be financial advice. I don't give it, and you shouldn't follow it. Talk to your investment and tax professional before you make any investment moves.)

This little gem from Seeking Alpha sums up my point of view quite nicely.

Check it:

'Dead Market Walking': Correction Just Around the Bend

Posted on Apr 30th, 2007 with stocks: DIA, IVV, SPY

Michael Panzner submits: “Dead man walking” is the phrase shouted by guards when a condemned prisoner is taken down to Death Row. The words have also been used to describe individuals who face an unwelcome but unavoidable fate. In other words, although they might be employed or involved in a particular relationship right now, circumstances will soon change — for the worse.

In many ways, this epithet describes today’s U.S. equity market. That is despite the fact that the majority of investors seem to believe that the increasingly exuberant run-up we’ve seen since the fall of 2002 can only lead to one thing: more of the same.

Yet while optimists might welcome news that the current bull run is four-and-a-half years old, “only three out of the past 15 bull markets have lasted five years or longer, with the average surviving only 3.4 years,” according to Jim Stack, editor of the InvesTech Market Analyst newsletter, in U.S. News & World Report.

What’s more, “even that's distorted by the longevity of the 1990s bull,” the magazine writes. “The median length of a bull market— the statistical point where an equal number last longer or shorter— is only 2.6 years.”

The current bull market has also been unusually correction-free. Despite the swoon that took place two months ago, share prices have yet to experience a typical, but healthy, pullback. According to the International Herald Tribune, again citing the research of Mr. Stack, “the past four years have been the second-longest period during which the S&P 500 has gone without a 10 percent correction (the longest was a six-year stretch in the 1990s).”

Many of those on and off Wall Street have welcomed the sometimes frantic buying we've seen, especially of late, which has helped push the Dow Jones Industrials Average to 13,000. Even so, the record-setting string of 19 higher closes in 21 trading sessions that has occurred over the past three weeks, coming as it has after a multi-year run, is characteristic of the kinds of climactic blow-offs that investors should fear rather than cheer.

As to why this particular bull market has gone past its presumed sell-by date, the explanations seem to fall into two categories: technical and fundamental.

With regard to the technical factors, many market-watchers argue that, especially in recent years, the equity boom has been aided in large measure by a rapidly shrinking supply of publicly-traded equity resulting from corporate buybacks and a plethora of large-scale, debt-fueled leveraged buyouts.

This week’s Barron’s, for example, reports that “since September 2005 some $628 billion of U.S. shares have been repurchased” by listed companies, according to data from Thomson Financial. The publication also notes that “last year, U.S. M&A deals jumped 21 percent to $1.45 trillion, about a fifth of those LBOs.”

These two developments have undoubtedly been a major positive for share prices. Unfortunately, they have also sown the seeds of their own demise: they set the stage for a coming tsunami of equity supply that will eventually overwhelm the market, most likely sooner rather than later.

As the credit cycle turns, companies that have wracked balance sheets in pursuit of short-term operational leverage will quickly discover that borrowing has become a costly financing alternative. With the debt spigot running dry, many will be forced to try and raise equity capital instead, on increasingly onerous terms...

... To be sure, some optimists might challenge this view, clinging on to the misguided notion that the economy is in a Goldilocks state — not too hot, not too cold, but just right. Many took comfort, for example, from the fact that despite the weak GDP report, consumer spending apparently held its own. With two-thirds of the economy dependent on the purchasing decisions of the Average Joe, it is hard not to feel the same way.

But this is not a forward-looking perspective. The reality is that most people have nothing in reserve, as evidenced by the fact that the nation’s personal savings rate continues to hover near multi-decade lows. The bursting property bubble means many prospective consumers can no longer tap the equity in their homes. Meanwhile, many Americans are stretched to the breaking point, with household debt service payments and financial obligations as a percentage of disposable personal income hitting a record 14.53 percent in the fourth quarter, according to the Federal Reserve.

What’s more, even though some data give the impression that consumers are still in the game, a slew of anecdotal and industry specific reports, including many that relate to the travel, auto, building materials, furniture, and other sectors, suggest otherwise...

I believe it was Napoleon that said that History is a fable agreed upon.

Well dear reader, I think that the world is starting to wake up and see that American economic might is nothing but...

a fairy tale.

Kumogakure.