Financial markets have an annoying tendency to reach overvalued or undervalued conditions that can continue for several years prior to reaching a critical turning point. On a short-term basis, the stock market has been called a "voting machine," driven by either "greed" or "fear" as the source of direction. On a long-term basis, the stock market is considered to operate as a "weighing machine." In other words, the weight of the evidence of true valuation will eventually overtake the herd mentality of the voting machine. Recent examples include:
1. The Tech Bubble of 2000-2002
2. The Real Estate Bubble of 2008-2009
3. The current 2009-? "Artificial Stimulus" Bubble, where stocks are rocketing upward. I believe that this current rocket does not have adequate fuel to pierce through the atmosphere and will likely, run out and come crashing down to earth instead.
Feelings About 2011As we entered 2010, I was on record stating many concerns that influenced how aggressive (or not) I have been in WFG portfolios that allow me the discretion to alter the allocation to stocks. I appear to have been early. That said, I have not changed my opinion and based upon the current economic landscape and stock market levelsm I am equally concerned as we enter 2011.
The Punishment For Being Ahead of the Game--But Right Nonetheless
In the past, investors have severely punished financial advisors who were perceived as too cautious as stocks and real estate kept growing towards the moon.
Jeremy Grantham Example
His world-class investment firm had its assets under management shrink 45 percent in the late 1990s as his pessimistic outlook for high-priced technology stocks spurred clients to buy better-performing mutual funds. While ultimately being right, like all humans, he was unable to predict with precision the exact date that the earth would stand still. The 49 percent plunge in the S&P 500 from March 2000 to October 2002 proved Grantham, 72, was right to warn of overvalued U.S. shares.
The Herd is Overweight Emerging Markets
Investment strategists at Bank of America Corp., Credit Suisse Group AG and Societe Generale SA have all said in the past month that emerging-market stocks may climb above levels justified by companies’ assets and earnings because of surging economic growth and the Fed’s efforts to reduce yields on debt securities.
Investors poured more than $60 billion into emerging-market stock mutual funds in 2010. Professional investors are more bullish on emerging markets than any region, according to a Bank of America survey last month.
“Everyone and his dog are now overweight emerging equities, and most stated intentions are to go higher and higher,” Grantham, who helps oversee about $104 billion, wrote in his quarterly letter to clients posted on the firm’s Website. Developing nations’ faster expansion “will give a powerful impression of greater value,” he said.
Valuations are the “most stretched” in emerging markets, making them vulnerable to a selloff should global growth disappoint investors, Bob Janjuah, the co-head of cross-asset allocation strategy at Nomura International Plc, said in a Bloomberg Television interview on Oct. 27.
Stocks, bonds and currencies in developing nations are likely to climb to bubble levels as the Fed has rolled out another round of bond purchases, Michael Hartnett, Bank of America’s chief global equity strategist, wrote in an Oct. 21 report.
Credit Suisse’s London-based global equity strategist Andrew Garthwaite says the combination of high savings rates, negative real interest rates and rising asset prices has made emerging-market countries including China and India vulnerable to speculative inflows.
“If ever the stage were set for an emerging market bubble, we think it is now,” Garthwaite wrote in an Oct. 27 research report.
Summary
“The headache posed by bubbles depends on the asset managers’ perspective,” wrote Grice. “For skeptics, the pain is on the way up; for true believers, it’s on the way down.”
I am still more comfortable at this juncture accepting the "pain of being early" vs. not safeguarding our client's wealth from what I believe is another bubble brewing.
