The stock market reached record highs in August as investors shrugged off the U.K. vote to leave the European Union and central banks including the Federal Reserve showed no sign of curtailing monetary stimulus.
But now is not the time to be complacent, says investment adviser Michael Lewitt, who recommends holding cash and gold while waiting for stock and bond markets to provide better values.
“Stock prices are severely detached from fundamentals,” he writes in the September issue of his Credit Strategist newsletter. “Valuation is generally a poor timing tool because periods of overvaluation can persist far longer than appear reasonable. Nonetheless, sooner or later overvalued markets correct to the downside and can erase years of returns."
The S&P 500 index of the biggest public companies has risen 6.8 percent this year, and is 2.6 percent above the prior record in July 2015.
Lewitt cites three reasons to be cautious with stocks:
1. Stocks Are Too Expensive. “Stocks are trading at the highest multiples of earnings since 2000 and before that 1929 – the Shiller Cyclically Adjusted Price/Earnings Ratio, which measures market value over time rather than as a snapshot, is at 27, the highest since those two peak years that were followed by catastrophic losses.”
2. Capital Misallocation. Lewitt cites data that show public traded companies are returning record amounts of money to investors in the form of dividends and stock buybacks.
“Capital returned to shareholders is not invested back in businesses to increase their productive capacity and future earnings power,” Lewitt says. “This is cannibal capitalism; the only question is when shareholders become the main course.”
3. Central Banks, Sovereign Wealth Funds Don’t Care If They Overpay. The Bank of Japan is buying billions of dollars in stocks (by buying exchange-traded funds that invest in equities), while the Swiss National Bank is buying stocks directly on the open market. On top of that, sovereign wealth funds that invest on behalf of countries like Singapore or Norway are buying stocks with the intention of being long-term owners.
“Rather than acting as lenders of last resort, these central banks are meddling in stock markets and inflating the value of companies to dangerous levels,” Lewitt says. “While these buyers can hold these stocks indefinitely, they are driven by different motivations than traditional investors seeking an attractive risk-adjusted return on their capital.”
Stock purchases by central banks deserve greater scrutiny, Lewitt says, because owning corporations is outside their purview of maintaining monetary stability.
“There is no good reason why a central bank should own stocks,” he says. “That is not what central banks were created to do. Central banks are supposed to act as lenders of last resort, not prop up stock prices.”
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