After a surprise move from the Federal Reserve last month, we have come to expect another surprise to happen this week. In our point of view, the FED won’t taper its current bond-purchasing program. Its chairman, Ben Bernanke, is worried about the effects that such a move could have on the economy and government finances. Even if the committee is able to foresee tapering occurring this year, we hardly see it happening. It is our belief that Ben Bernanke will most likely push for a quiet and peaceful end of mandate as chairman of the board.
The sluggish economic growth and the high unemployment rate are the most important issues delaying the “tapering.” However, there are a few other factors that are also contributing to it. FED’s chairman, Ben Bernanke, is at end of its mandate. With Janet Yellen being a known dovish and taking office in two months time, why would Bernanke push for a hawkish stance at this point? At the same time, the government shutdown is expected to have some impact on the economy. Until the situation is under control, the FED may prefer to wait rather than to act.
No matter how soon tapering happens, the main concern for investors should be with company earning, particularly, how these relate to current prices. QE 1,2 and 3 contributed to push asset prices higher, but earnings haven’t been growing at the same pace. The Case-Shiller P/E ratio is now pointing to 24.74, a level 50% above its long-term mean.
It is true that during the 90s this index increased for several years before a crash occurred. Even after being highly above its long-term mean, the P/E ratio can continue rising for many years, so we can’t be sure about when it will revert back to the mean. But, we are sure that ultimately it will have to revert back.
When you buy a company’s stock, you’re buying a share of its future profits. The greater the profits, the higher the stock price should be. If earnings stop growing or grow less than the stock price, you are paying more and more for each single dollar of profit. Do you think this is sustainable?
The fact of the matter is that it isn’t sustainable, and you should always look at earnings growth and other fundamental variables before buying any stock. Currently the market is becoming overvalued as a whole. Because of this, we need to see faster earnings growth or a price decline before being tempted to buy with more conviction. At these times, it makes a difference to carefully choose our investments rather than buying the broad market.
As a final note, we believe that even though the market reaction could be very negative, it would be much healthier for future investments if the FED decided for the taper now. Stock prices would experience some correction, helping prices catch up with earnings and dividends. If that is not the case, money will continue to flow to risky assets and make stock prices rise faster than earnings, which is unsustainable in the long-term.
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