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Macro Update


I was reading a great article by Damien Cleusix whose aim was to remind us that in 1996 Fed President Allan Greenspan said the stock market had entered a period of irrational exuberance. Of course it went on to move significantly higher over the next four years before we experienced the NASDAQ Crash that took all assets down in price significantly.

In the article, Mr Cleusix points out that today, based upon a typical valuation measure he uses (Price to Sales) to value the S&P 500 Index, we are 40% higher (or over-valued) today than we were when Mr Greenspan made his statement about irrational exuberance. Today’s level of valuation based upon the Price to Sales Ratio is the same value where the S&P 500 Index stood at the time of the NASDAQ Crash.

As I’ve listened to the various pundits on investment television over the past couple of weeks, there has been a lot of talk about the stock market continuing to move higher until we see some sort of systemic crisis that knocks 40% off its value. I don’t know if the people I heard were referring to Mr Cleusix’ analysis or not, but it got me thinking that the readers of this blog might like to know if the indicators I follow are pointing to some sort of systemic crisis.

In a blog post in September called Benny and the Inkjets [click the link to go to the post] I introduced you to some of the systemic indicators I follow and noted that they were not flashing warnings of any sort of systemic problem being around the corner. In this posit, I will show you those same indicators again but I’ll let you check out the previous article for a more in depth discussion of them.

At the top of this post you have the TED Spread. It is not showing any sort of stress on the system at the present time.


Above we have the Kansas City Fed’s Financial Stress Index. Again, it is not showing any sort of stress at the present time.


Above is the Recession Probability Index. It is not showing any indication of recession at the present time.


Above is the Chicago Fed Financial Conditions Index. It is not discussed in the previous post, but this index measures risk, liquidity and leverage in money markets and debt and equity markets as well as in the traditional and “shadow” banking systems. Readings below the zero line indicate there is ample liquidity in the system. It is not showing any sign of a liquidity crisis at the present.

So, based upon these indicators, I do not see any sort of systemic crisis on the horizon at the present time.

However, the market continue to get more overvalued (I can agree with Mr Cleusix on this point). In the previous post, I showed you the Shiller P/E and explained its importance. Here is the current graph:


This month’s reading shows a Shiller P/E of 24.77, up from 24.21 last month.

As long as Benny continues to keep the ink flowing, the most likely scenario is that the cash flowing into the markets will keep pushing things higher. But if the market gets any sort of whiff that the Fed is going to cut back on its monetary stimulus (look for the word “taper” as the key to this) then you will likely see the stock market pull back, maybe significantly, even if there is no systemic issue. That is just the nature of an overvalued market – it can continue to become more overvalued until something changes the psyche of the investing public and they become sellers instead of buyers.

Click here to watch today\'s video on YouTube

Enjoy the weekend!