Saturday, April 15, 2006

Ring, ring. Ring, ring. (Hello, is anybody there?)

And who says they don't ring a bell at the market top (or close to it)!

I think that the US market is very close to a top for the next several years, and it isn't because stocks are overly expensive. There's been lots of research showing that, relative to recent historical norms, stocks remain at roughly fair value (I'd define fair value as within 10% of its perfect actual value). The PE ratio of the S&P500 at about 18 or 19 isn't something to get alarmed about.

What is, is the rising interest rates. This will drain liquidity from the market as rates will be - I predict - rising far above that foreseen by most commentators today. That's because interest rates aren't just used to control inflation - but to support a weakened currency and attract needed outside financing, when a deficit situation exists when internal lenders no longer buy enough bonds to support the deficit (i.e. the USA today). In two years, I predict that a 30 year fixed mortgage will be in the 8.5% to 10.5% range, between 200 to 400 basis points higher than today.

Secondarily, the downdraft from the real estate market (expect that to be a serious force about 12 months from now), will also drain liquidity from stocks, as some owners of investment or secondary real estate, will partially cash out of the stock market to support their increased real estate loan payments. Others will sell their investment or secondary homes, but with the stock market also in a secular decline, won't redeploy their additional capital (if that exists for them), into the stock market. They'll keep it on the sideline in CDs and other savings intruments that will have relatively attractive yields.

Finally, the yields of savings instruments will continue to become more attractive, and will also compete for cash that recently was almost automatically deployed into the stock market, or real estate.

Real estate and the stock market returns will be well correlated over the next three to five years. Negative returns. Or am I the only one that hears the bell ringing?


The Confused Capitalist

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