More Signs of a Toppy Market

The stockmarket today posted another new high, yet the drip, drip, drip of less than cheery economic and political news continues (or have market participants forgotten that governments are bigger than they are?). But the markets focus on whatever good news there is, and the spectacle of Bernanke reassuring Congress also soothed, perhaps anesthetized, investors.

The reason this is a concern isn’t simply that the stockmarket might fall and/or the economy might slow down. There is a real possibility of serious dislocation in the asset markets with collateral damage in the real economy. Even though interest rates are higher than they were several years ago, debt is still cheap. Credit spreads are tight in almost all markets, and terms are lenient. But if we see a crisis that is bigger than one organization and spurs a flight to quality, and you’ll see the debt spigot turned off. And consumption and growth in the US have been running on debt.

So the greater the disconnect between economic fundamentals and market valuations, the nastier the correction when it finally comes.

Michael Steinhardt, one of the original hedge fund operators (and one of the very few who had a good enough sense of timing to retire with his reputation intact) in the days when they were few in number and delivered superior performance, sounded a warning in a Bloomberg interview:

Michael Steinhardt, the investment pioneer whose hedge funds returned more than 20 percent a year for almost three decades, says the bull market in U.S. stocks may be coming to an end after more than four years.

“Very few people have the ability to pick a high, and I don’t think that this is the exact moment,” Steinhardt, 66, said in an interview yesterday in New York. “One stays long, but one becomes very sensitive. You say to yourself that the next major, major move is going the other way.”

Steinhardt said some investors were using too much debt to boost returns, and the dollar may get support from a decline in the U.S. budget deficit….

Steinhardt sees greater risks now than in the past from the potential for stocks to decline “in a meaningful way,” defined as by 10 percent or more.

“Coming back to the area where the excess might be, I think it’s in leveraged investments,” including commodities and real estate, he said. “The rules related to borrowing money have loosened up extraordinarily. This is something we should remember.”

Mainstream media outlets are acknowledging what has already been hashed over in the blogsphere, namely, that the fourth quarter GDP growth figures will be revised downward. Nouriel Roubini, in his wrap up of macroeconomic news on RGE Monitor, points out that it is “mostly weak”:

– January retail sales unchanged (0%) relative to December….this is a bad sign.

– Industrial production fell in January, by the most in more than a year. The fall was quite broad-based but the drop in auto production was severe…

– We had a surprising and large increase in initial unemployment claims. This is not just a random one week event: the four-week average jumped to 326k from 308k. Also continuing claims sharply increased by 71,000 to 2.560 million in the week ending February 3. This is the highest level on continuing claims since January 2006. 350k initial claims is very high similar to levels seen in US recession. But we will need to look at the next few weeks to see if this spike is temporary or persistent.

– The Empire State (NY) manufacturing index for February increased from 9.1 to 24.4. This is a good piece of news for manufacturing today…

-The NAHB housing market index for February increased from 35 to 40 in February. This is a good leading indicator of the housing market….This index is at odds with some of the other indicators…

Overall mixed data but with some significant and serious weaknesses (sales, manufacturing and initial claims).

Update: The Philly Fed Report for February, an important leading indicator of manufacturing, also showed weakness. The Philadelphia region’s manufacturing weakened in February since orders fell and shipments weakened. Also, the derived composite fell to 49.5 from 53.5. That is the lowest level of the composite since August 2003. Another signal of manufacturing weakness.

The poor employment data is noteworthy because the Bush Administration has been trying to sell the story that job creation is strong.

Although Roubini found a bright spot of housing news, a story from the AP on the same topic was downbeat:

The slump in housing deepened in the final three months of last year with sales falling in 40 states and median home prices dropping in nearly half the metropolitan areas surveyed….

While some economists said they believed the worst may be over for housing, others predicted more price declines to come until near-record levels of unsold homes are reduced….

Nationally, sales declined by 10.1 percent in the fourth quarter compared with the same period a year ago. The national median price — the point where half sell for more and half sell for less — fell to $219,300, down 2.7 percent from the fourth quarter of 2005….

Mark Zandi, chief economist for Moody’s, predicted that home prices in many parts of the country would continue to be under pressure for the rest of this year as the market works through still large inventories of unsold homes.

He said this process will be made more difficult with banks raising lending standards because of concerns about rising mortgage default rates.

“The price declines we are seeing are extraordinarily broad-based and just symbolize how significant a price correction we are in,” Zandi said.

“We are seeing the declines concentrated in the industrial Midwest, where the job market is a mess due to the layoffs in the auto industry, and in markets such as Florida and California” where a heavy influx of speculators had bid up prices, Zandi said.

Similarly, if you look at The Housing Bubble Blog, you’ll grim stories from local markets all over the country.

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