The U.S. stock market is overvalued and ripe for steeper declines as the global economy weakens, said strategist Michael E. Lewitt.
He forecast that the third-quarter earnings season, which begins this week, “will be lousy” and will lead companies to focus on their debt instead of planning new rounds of supportive stock buybacks.
“It is also a bad sign that we are starting to see bubbles burst in serial fashion — the latest being biotech stocks,” he said in the October issue of his Credit Strategist
newsletter. “Those who still own the more speculative parts of the market like biotech and social media should get out while you can.”
The S&P 500 index
of the biggest publicly listed companies hit a record of 2,135 on May 21 before sliding by 12.4 percent three months later as oil prices
weakened and investors worried about China’s economic health. Lewitt forecast the market benchmark will end the year at 1,875 to 1,900, compared with its current level of about 1,978.
“I see little reason for optimism because the conditions that caused the correction are not going to change: overvaluation, China, commodities, dollar strength, global economic weakness and geopolitical chaos under the most incompetent, lawless and immoral foreign policy administration in memory,” he said.
Lewitt founded Harch Capital Management Llc. in 1991 and has published The Credit Strategist since 2001, according to the website of his Boca Raton, Florida-based firm. He published “The Death of Capital” in 2010.
The Shiller cyclically adjusted price-to-earnings ratio
, a measure of how expensive stocks are compared with their profitability, fell from 27 times to 24.7 times. That’s still above the long-term mean of 16.6 times, indicating that stocks are expensive and could decline more, Lewitt said.
Emerging-market countries are losing steam, including China, which has the second-biggest economy after the U.S. The official manufacturing Purchasing Managers' Index in China, a key indicator of factory conditions, rose slightly to 49.8 in September from 49.7, but readings below 50 indicate a contraction.
The market’s direction will depend on the credibility of the Federal Reserve and other central banks, Lewitt said. Fed Chair Janet Yellen said hikes in interest rates are coming this year as the labor market improves, but that was before the non-farm payrolls report
on Oct. 2 showed that the U.S. economy last month added fewer jobs than forecast. Meanwhile, the Fed's preferred measure of inflation
is below the unofficial target of 2 percent.
The Federal Open Market Committee that sets U.S. monetary policy has kept interest rates near zero percent
since 2008, when the U.S. economy suffered its steepest decline since the Great Depression. The Fed also undertook several quantitative easing programs to buy trillions of dollars of government and mortgage debt to help keep rates low.
Lower interest rates make it cheaper to borrow, which can help to boost spending and investment.
“The Fed is now facing the very real possibility that it will have to resort to more QE rather than raise rates,” Lewitt said. “Brave talk by Mrs. Yellen and her colleagues that markets should expect a rate increase by year-end grow dimmer with every down-tick.”
He said investors need to watch the value of the U.S. dollar in relation to other currencies. The dollar has strengthened since 2014 with the expectation that the Fed would raise interest rates, limiting the money supply.
“The dollar is the single most important financial instrument in the world and readers should focus on it intently with respect to all their investments,” Lewitt said. “And as they are doing so, they should continue to buy gold and save themselves.”
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