In-depth analysis on Credit Writedowns Pro.

Market Is Overbought, Overextended and Overvalued

by Comstock Partners

After an 86 percent gain in 21 months the market looks overbought, overextended and overvalued. Furthermore the economy is unlikely to grow enough to reduce unemployment, lead the Fed to raise the funds rate or cause any significant amount of inflation.

Although the combination of QE2 and the White House/Congressional compromise on the tax extension issue is being touted as the great elixir that will spur economic growth we think that growth will be subdued and temporary. Indeed QE2 is already looking like a failure in its early stages. No matter what the "experts" say now, it was crystal clear from the get-go that the Fed’s intention was to lower long rates, not raise them. As it stands today the sharp rise in the 10-year Treasury bond is likely to further weaken an already dead housing market by enough to offset any additional growth that QE2 could have provided. Furthermore, the combination of QE2 and the big projected increase in the budget deficit caused by the compromise tax bill has helped spur another jump in commodity prices that will reduce real consumer income and negate much, if not all of the intended boost to consumer spending.

In addition economic growth will be tempered by the temporary nature of the stimulus, continuing high unemployment, a moribund housing sector, the dire condition of state and local finances, a lack of readily available credit and the on-going fragility of a banking sector that is still loaded with toxic assets that are significantly overvalued on banks’ balance sheets.

Another major headwind to growth is the on-going need to reduce household debt to normal levels after the credit binge of recent years. Consumer credit excluding student loans continued its year-long slide in October, falling by $32.5 billion, and the unwinding has barely started. Although consumer spending has perked up recently, we note that a national survey indicated that the percentage of people saying that they used their credit cards over the Thanksgiving day weekend was the lowest (17%) in the 27-year history of the survey. According to major credit card companies, the use of personal credit cards dropped 11% in the 3rd quarter from a year earlier. Does all of this sound like a consumer ready to spend freely? We think not.

As if all of the above weren’t enough, the chances of financial and economic crises overseas, particularly in Europe, China and Japan are exceedingly high. The turmoil in the European Union is not a temporary crisis that will be cured with the wave of a wand. A number of the weaker EU nations are basically insolvent, and their debts, sooner or later will have to be restructured. The New York Times and Wall Street Journal recently highlighted the exposure of German, French, British and Spanish banks to the debts of Greece, Ireland and Portugal. The IMF has warned that if the EU doesn’t come up with a permanent solution the EU economy could go off a cliff. Meanwhile the austerity measures being imposed on the troubled countries will be a drag on the EU economy for some time to come. As for China and Japan, we’ll leave that for future comment.

In light of these problems we believe that investors are overly optimistic. An 81% market rise in 21 months has already discounted a lot of good news—-some of which will not happen. The market looks overbought and overextended, and is showing signs of an imminent top with lagging breadth, a lower number of new highs, overenthusiastic sentiment, higher-volume down days and a more frequent number of late-day selloffs. At this juncture we think that potential upside progress is limited while downside risk is high.

About 

Comstock Partners, Inc. analyzes economic and financial conditions from a long-term macro-economic perspective and makes adjustments based on cyclical and shorter-term considerations. In pursuit of its goals, the firm invests in various asset classes including domestic and foreign stocks, bonds, currencies and derivatives including indices and options. For the Capital Value Fund, Comstock Partners can buy or sell short and make use of leverage in order to maximize returns under various market conditions. In effect, we believe our operation resembles a modern-day hedge fund in its scope of activities.

10 Comments

  1. Joseph rogers says:

    This is an amazing summary. I’d like to thank Richard Martin from the “Wake Up Call” for sending this out to his audience. His economic commentaries can be found at this link and are worth a listen.
    http://www.progressiveradionetwork.com/wake-up-call/

  2. DavidLazarusUK says:

    The markets are seriously overbought but as Keynes commented they can remain irrational longer than anyone expects. I expected the markets to have another leg down months ago, but they still climb. When the crash comes it will hurt the economy much more as confidence will finally evaporate from housing and making bank losses incredibly toxic to all bond holders. Then the government will have to allow the big banks to fail, as they cannot afford to keep funding bonuses when everyone else is losing their home.