How much more bull can world markets bear?
It is getting virtually impossible to find an expert who believes global equity markets are a risky place to invest. As markets on all continents grind higher and higher, the bears are in danger of becoming extinct and the Winston Churchill "voice in the wilderness" warning us of the troubles ahead seems to have departed the scene. When everyone is in agreement, we should start to get a little worried.
Let's roll the tape.
Permabear Nouriel Roubini capitulated two weeks ago by shelving his concerns of a pending financial disaster and declaring the equities bull market could last another two years.
Last week billionaire hedge fund manager David Tepper stepped up to the plate and declared in a rare interview, "guys that are short better have a shovel to get themselves out of the grave". Tepper's is the same message that Warren Buffett gave recently when he said equities were still the best place to invest.
Meanwhile, two New York Federal Reserve economists, Fernando Duarte and Carlo Rosa, recently delivered a paper that concluded stock prices in the US, based on the risk-free rate of return, were as cheap today as any time in history. Quite remarkable given the US market has risen 140 per cent since March 2009 following the global financial crisis.
All this is being driven by a historically low risk-free rate struck from US Treasuries. Under this measurement the Dow Jones could climb another 25 per cent to 20,000 points and trade on a price-earnings (PE) multiple of 18 times before it started to look stretched.
The Duarte-Rosa paper also shows that if interest rates were allowed to rise to normal levels, rather than be suppressed by central bank purchases, the story would be completely different and equities would be expensive.
We are living in a false economy. If everyone believes the false economy is the new normal and the only game in town is equities, then we are setting ourselves up for a nasty correction sometime soon.
The overwhelming view among investors is that central banks around the globe will continue to print money and keep interest rates low for the foreseeable future. This will underpin global equity markets because investors are forced out of cash into higher-yielding equities. This consensus view has taken more than four years to solidify and was sealed when Japan's moribund sharemarket sprang to life after its central bank started printing money again. Typically, consensus is viewed as a critical ingredient to success; when it comes to sharemarkets it is usually a prelude to disaster.
Until very recently markets around the globe have been climbing a wall of worry. These concerns seem to have almost dissipated. The VIX Index in the US, which is also known as the "fear index", has sunk to its lowest since early 2007.
These are dangerous signs. Bull markets have a tremendous ability to suck everyone in before they conclude. One by one the doubters who are either "short stocks" or are cowering in cash feel too much pain as the market rises by the day. The tech boom in the 1990s and the epic rally in resources in Australia over the past 10 years both eventually bewitched everyone before they both collapsed.
In the short term I am still a bull. I am on the record as saying the S&P 500 Index in the US can rally another 3 per cent to 1700 points and the All Ordinaries can climb a further 9 per cent to 5600 in 2013. Driving this last leg of the current bull market should be economically cyclical stocks, while the financials and defensives take a breather. Beyond this point I have no confidence with valuations stretched to unhealthy levels.
Virtually everyone has conceded it is impossible to "Fight the Fed" and win. But the reality is if you cross the road looking only one way, the odds are a car coming from the other direction will mow you down.
Sharemarkets around the globe have been on a tear over the past 12 months. Look at the following upward moves: Britain 23 per cent, the US 24 per cent, Australia 24 per cent, Germany 31 per cent, New Zealand 32 per cent, Turkey 58 per cent, Japan 69 per cent and Greece 104 per cent. Money is being pumped around the world by central banks and it is funnelling into equity markets because cash and fixed interest offer next to no yield.
It is almost impossible to say what will serve to derail the 50-month-old bull market in the US. It could be a simple surge in economic growth that causes a selloff in bonds and a spike in yields. In the long term that would be good for sharemarkets, but it would ensure a big correction in share prices in 2014. Alternatively, it could be that economic growth fails to emerge and we all become highly sceptical that the trillions of dollars of financial stimulus of the past five years have amounted to anything.