Saturday, October 16, 2010

The Stock Market Rally Continues

The rally in US financial markets continues unabated as Wall Street continues to party in anticipation of the Federal Reserve's purchase of $1 trillion worth of assets.

In other words, as mentioned in last week's article, $1 trillion of money created out of thin air by the Federal Reserve will flow directly into Wall Street's coffers.

But let's take a step back and ask ourselves whether these levels of stock market valuation are justified.

The S&P 500 is currently selling at a PE ratio (price/earnings) 50 percent higher than the long-term historical average. Investors must think that corporations are going to grow 50 percent faster than they did during most of the 20th century.

Does that even begin to make sense? Well, let's see.....

There is about $20 trillion worth of bad credit still to be many houses are headed to foreclosure that banks have had to stop taking them back...unemployment is at levels not seen since the Great Depression with the "real" unemployment - U6 - over 17 percent.

And let's not forget that what little economic growth we've had has come from the government and now Uncle Sam is headed for a debt crisis - the US government now borrows a dollar for every dollar it receives in taxes! No wonder the dollar keeps spiraling down!

Yep, it makes sense - not. What is happening here is that the Federal Reserve believes that all economic problems can be solved by creating money out of nothing, and giving it to Wall Street, creating one financial market bubble after another.

Speaking of bubbles, the biggest of them all - the US Treasuries market - continues growing. It is being aided by continuing flows from individual investors into bond funds, thinking that these funds are safe.

The numbers speak for themselves. More money has flowed into bond funds over the past year - $412 billion - than flowed into stock funds in the 12 months leading to the 2000 tech bubble high - $312 billion. I don't have to tell anyone what happened to those investors.

What do I expect? I would expect a solid correction in at least the stock market during the period in early November when the Federal Reserve "officially" announces how much money they're going to print - "buy the rumor, sell the fact".

If that does not happen and Wall Street keeps inflating the bubble, then we won't see a correction until at least mid-January. And then it could be a very nasty one, ala 1987.


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