Mae West, Dolly Parton and the Top Heavy Markets

I was discussing the markets with a very experienced an knowledgeable colleague about how "toppy" the equity market is. I told him it is "Mae West" toppy. It is "Dolly Parton" toppy. The tell-tale signs for us is the retail order flow into riskier vehicles and equity market participants positive spin on nearly economic report. Today, retail sales came in below the street consensus and the prior month's data was adjusted down. Empire Manufacturing came in well below economists expectations. Fed Chairman Ben Bernanke warns of headwinds ahead and the need for continued extraordinary monetary accommodation. In response the equity market rose 136 points.News reports indicate that many equity market experts were encouraged that retail sales turned positive. However, the fixed income market had a much different response.

Fixed income market participants took the weak economic data and Mr. Bernanke's comments for what they were and the result was a sharp rally of the prices of long-dated treasuries. Is it that the fixed income experts are smarter than the equity experts? Not really, it is just that the fixed income market participants are more honest. The equity geeks know that the economic fundamentals do not justify current equity market levels. They are hoping that they can force a self-fulfilling prophecy. That the weak dollar is helping to fuel the rally encourages the equity participants. They don't care why the market is up, only that it is up. That is until they want to take profits and then they are the first out the door.

Another sign that the equity (and fixed income credit markets) may be overdone are comments that certain phenomena "always" follows data which we are seeing now. Always is a long time and can the data can be selectively gathered by using time periods advantageous to one's argument. I say that "always" is a word that we should "never" use. Have we ever had current levels of household debt before? No. Have we ever had an economic malaise with interest rates already affective at zero? No. Have we ever had a global economy with a fierce battle for market share before? No.

What many "experts" decline to discuss is that current levels of unemployment were last seen in the early 1980s, before nearly three decades of ever-lower interest rates. The fact is that the robust growth and very low unemployment experienced since the 1980s are fundamentally unsustainable. They were fueled by ever lower interest rates and ever easier lending standards which resulted in ever higher home price which resulted in ever more home equity to be used to buy lifestyles unattainable by way of income alone. The problem is that such home price increases (and the resulting growth in home equity) is unsustainable. Now we have reverted to the mean, maybe a little below the mean, but current economic activity is much closer to fundamental levels than the credit-fueled spending binges of the 1990s and 2000. Bill Gross has it right, get conservative now.