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Warning Signs of an Overheated U.S. Stock Market


Washington, DC -- (ReleaseWire) -- 04/16/2014 --For those that are actually loving the rise in this U.S. financial market, Warren Buffett has some pretty cheeky advice to share in his annual letter to the Berkshire Hathaway shareholders. He was remembering the late Barton Biggs, the first and foremost global investment strategist, when he opined on times like these in the marketplace; so, Buffett wanted to quote him: "A bull market is like sex. It feels best just before it ends." Now, as much as the thought of Warren Buffett and saying the word "sex" in the same sentence is weird and uncomfortable I have to say, Buffett with this comparison, actually has a point, says Dawn Bennett, Founder of Bennett Group Financial Services. She goes on to say the following:

The U.S. financial markets felt pretty good recently, didn't they? The S&P 500 index actually touched an intraday record recently. So, why be so antsy? Why would we want to talk about some warnings instead and not be willing to give into that feel-good moment we all had last week?

Well as most U.S. companies prepare to report first quarter results in a few weeks, approximately 108 have already warned the Street to brace themselves for worse than expected profits. This is versus just only 16 that have pointed to better surprises. Now, Thompson Reuters, the worldwide news coverage service and research house, reported that Wall Street had originally expected first quarter 2014 profits to grow by 6.5 percent year over year. But today, that growth has dropped down to 2.1 percent, which really isn't very sexy, is it? Nor is it sexy in the long run, for those investors thinking the rise we had this week will continue. Plus, what really will be unnerving to investor portfolios is how the U.S., which led the world in the largest amount of quantitative easing ever, will soon be leading the world into monetary tightening.

Recently the new Fed Chair, Janet Yellen, shocked the marketplace by projecting when, after the Fed ends its buying program, they will raise rates. She said that between the end of quantitative easing and the first rate hike, it just might be only six months. So, just like that, the countdown clock started. And just like that, things are going to be very un-sexy in investment portfolios if you own U.S. stocks and bonds that are dollar-denominated. What's worse is according to Stephanie Pomboy at MacroMavens, our one-time foreign financiers, China, Japan and Russia, have long since packed their bags, because they're afraid of the Fed's easy money program stopping.

Also they're afraid of rising interest rates because those are bad for stocks and bonds. Most of all, they are afraid of the faltering dollar. They used to provide us close to $1 trillion annually to fun d the federal budget deficit through Treasury purchases, and today they are only providing $15 billion annually.

Also, other foreign central banks have been net sellers of Treasuries to the tune of $78 billion. China and Japan have all but stopped their purchases, with Japan unloading about $100 billion in the past 12 months, and no, this isn't about Russia and Ukraine and Putin, or even Treasuries. This is about the U.S. dollar. They are so afraid to be paid back in funny money.

It's going to be the dollar that's going to be the value for our monetary sins, which will be a greater danger to the U.S. economy than anything Putin might ever pull off. So this is my first warning to all investment portfolios.

It has always been fascinating to me that as investors, we fail to pay attention to warning signs as long as we don't see any immediate and imminent danger. Yet, when the inevitable downside of anything occurs we refuse to accept responsibility for the consequences. This is why I want investors to really pay attention to these next few negative warning signs, because they are here for all to see.

The next warning sign that the markets are overbought is that the current valuation of the S&P 500 is lofty by almost any measure, both by the aggregate market as well as the med ian stock market. Furthermore, the adjusted price-earnings ratio, suggests that the S&P 500 is currently 30 percent overvalued in terms of operating earnings per share, and about 45% overvalued using reported earnings. Not good.

The third warning sign for investment portfolios is that there's an unusually high ratio of selling to buying by corporate senior managers. Today, corporate insiders are more bearish than they have been in almost 25 years, which isn't positive news for the stock market since these insiders, corporate officers and directors, know more about their companies' internal workings and future prospects than the rest of us. So investors might want to take some of their pessimism and size down U.S. stock and bond holdings. We've warned investors over and over again about an inflated U.S. stock market created by the Fed.

American investors need to pay attention to what's going on, because it's not going to be a “feel good” ending, which is why we are seeing the insiders sell. This is also why we’re also seeing these foreign entities walk away from buying even U.S. Treasuries, which were supposed to be, at one time, the safest paper obligations in the world.

Securities offered through Western International Securities, Inc. Member FINRA & SIPC. Bennett Group Financial and Western Internationa l Securities, Inc. are separate & unaffiliated companies.

All market data references are sourced to Bloomberg terminal database.