Stocks are off to a great start for the year. This was the same scenario at the beginning of 2010 and 2011.
Only two months ago, investors were worried about the collapse of the entire eurozone.
The Chicago Board Options Exchange's Market Volatility Index, known as the VIX or the "fear" index, was above 30, now it stands at 18, below its long-term average of 20.
Two months ago, I warned investors not to look at the macro picture. Stocks were cheap and usually rally at the time when the news doesn't seem like it could get any worse. It was a good call, as markets across the world have rallied, but now is a time for investors to be cautious.
The Shiller PE ratio, one of the best metrics for measuring stock market valuations is back above 22. This indicates that real equities returns should be below 2 percent annually for the coming decade. Furthermore, combined with high valuations, the macro picture is even worse.
I think Greece is about to default and now all eyes will soon turn to Portugal.
Though the IMF (co-lender of close to 80 billion euros ($106.34 billion) issued to Portugal in April 2011) described Portugal as “broadly on track,” it stated that the country needed reform in two large areas: public spending at the local level and financial regulation for state-owned companies.
Many predicted that Portugal would be able to return to public markets in 2013. However, recently Goldman Sachs disagreed. Goldman predicted a bond default if the country doesn't receive 30 billion more euros in bailout money.
Optimism faded further when the country was downgraded to junk in January. In late January, 10-year bond yields for Greece reached above 30 percent; and for Portugal, they went above 15 percent. This is a sign by investors that they don't have confidence in the country. By contrast, U.S. 10 year bonds currently yield below 2 percent.
Portugal is in such dire straits that the prime minister recently told unemployed workers to emigrate to other countries. Most countries try their best to mask problems, so when the head of the country practically states there are no more jobs, that is a really bad sign. What the outcome will be we don't know.
However, now is a time to look back at 2010 and 2011. Investors forgot about the problems in Europe. In both years right around spring time, problems arose with Greece, investors sold off stocks indiscriminately. Then European leaders took actions kicking the can down the road, and stocks rallied.
Investors seem to be repeating the mistakes of the two previous years.
Stocks are expensive and Europe has even more problems today. Investors who are concerned about capital preservation should be very cautious today in light of these headwinds.
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