This week may very well record the highs for the year as far as major global benchmarks are concerned. Equity markets have enjoyed this artificially induced rally, especially after central banks from Frankfurt to New York to Tokyo have acted in such an idiotic manner which allowed dumb money investors to keep pushing the markets to multi-year highs.
Does this sound familiar?
Well, it should. I have one word for you, actually it is a number: 2008. During the summer of 2008 investors ignored all the bad news and were in a state of trance or some sort of trip as if they just took a new drug that hit the market. A few sophisticated individuals warned that global financial markets are due to collapse as much as 50% and potentially more.
Those few sophisticated individuals were the laughing stock of the financial community similar to when Christopher Columbus claimed that the world is not flat and that one could sail around it without falling off a cliff. Their predictions were ignored and dumb money piled into equities as if they were free. Dumb money sent their mis-educated analysts around the globe in order to praise how cheap stocks are based on P/E ratios.
The P/E ratio is probably the dumbest indicator one can use to justify if the price of equities is cheap or expensive. Having said that, anything that has the ‘e’ component, ‘e’ stands for earnings, in its ratio should be thrown out and ignored. Earnings are the simplest component to manipulate with financial engineering in order to make it appear much stronger than they really are.
Speaking of earnings, third-quarter earnings season is around the corner and investors should prepare for heavy disappointments especially when it comes to fourth-quarter guidance and business outlooks going forward as they will fall short of already downward revised expectations. Earnings for the S&P 500 are expected to drop 2.2% in comparison to last year. The outlook for this third-quarter has not been this negative since 2001. The negative-positive ratio is 4.3:1.
All of the above are still too bullish as reality will show that the underlying earnings picture is much worse than anticipated. Add negative economic reports from the world’s biggest economy, the EU, the world’s second biggest economy, the U.S., and the world’s third biggest economy, China, into the mix with a negative third-quarter earnings season and you have the perfect storm for a sharp correction.
Some dumb money strategists as well as analysts believe that central bank manipulation from the ECB and Fed will provide a floor for the market through the end of the year. As always, dumb money is wrong. The manipulation of both central banks will not have a positive impact on consumers and therefore the economy. Current equity market strength counts on a stronger than reality global economy which investors will soon find out has been nothing more than a fantasy.
Financial markets do not sustain fantasy and the picture will soon be corrected in order to reflect reality which will translate in a sharp correction which may start in October and last for several months. Enjoy another Manic Monday as the future will have plenty more of those in store for market participants.
