The ‘Bernanke put’ is back. Or at least that’s what many bulls think.
By putting the taper on hold, Ben Bernanke appears to be offering a free insurance policy for investors. If markets start to fall, or the economy hits trouble, then Bernanke and the Fed will ride to the rescue with more money-printing.
So it’s little wonder that markets around the world have soared. And in the US, stocks have hit record levels.
Time to pile in then? I’m not so sure. I think there’s a very good chance that US stocks could fall in the very near future.
The looming economic stand-off in the US
My biggest concern about the US market is that a fresh economic crisis is looming. US politicians must approve a fresh budget by the end of the month or the government could shut down.
Even worse, Congress must also agree to raise the government’s ‘debt ceiling’ by the middle of October or we could see a government default on Treasury bonds. In other words, the government might not be able to repay debt to bondholders when various treasuries mature.
That could prove disastrous for financial markets, and the Fed would struggle to maintain stability. The ‘Bernanke put’ would be history.
Now, the idea of the US defaulting on its debt sounds mad. And if it did so, it would be entirely for technical reasons – the ‘debt ceiling’ is a self-imposed political barrier, rather than any sort of economic line in the sand.
But don’t forget that the previous debt ceiling deadline in 2011 triggered a downgrade in US government debt and a stock market wobble. Things only calmed down when Barack Obama and Congress agreed a last minute deal.
Of course, Obama and Congress may well agree a similar last minute deal this time around. That’s what politicians tend to do. But all the signs suggest it’s going to be tough.
Many Republican politicians are determined to block the president’s ‘Obamacare’ health reform. These legislators see the debt-ceiling crisis as the only way they can stop the scheme.
Easily compare UK shares by sector or index using our free performance tool.
And on the other side of the political divide, ‘Obamacare’ is arguably the president’s only major achievement (regardless of what your views are on it, it’s certainly his ‘legacy’ policy). So he’ll be determined to hold firm on this.
What’s more, the 2011 crisis was only averted by a deal that included automatic spending cuts from January this year. If another last-minute deal is agreed this time round, further automatic cuts look likely.
Again, whether or not you think such cuts would be a good thing, it would kick off more worries about the strength of America’s early-stage recovery.
A more important reason for caution
But politics aside, there’s an arguably more important reason to avoid US stocks just now. Crisis or no crisis, the market looks expensive.
The S&P 500 is trading on a price/earnings ratio of 16.5, according to Bloomberg. That’s above its historic average. And if you adjust for where we are in the economic cycle (using the cyclically-adjusted p/e ratio), shares don’t look cheap either.
It’s also worth noting that a relaxed monetary policy doesn’t automatically lead to higher share prices. The relationship between interest rates and share prices is less clear than the received wisdom would have you believe. As well-respected fund manager Alastair Mundy of Investec pointed out on Citywire recently, “Equities have had two shocking bear markets in the last 15 years, at a time when the Fed was easing”.
It’s true that US p/e ratios did tend to be higher when interest rates were low in the ‘80s and ‘90s, but as Mark Hulbert notes in the Wall Street Journal this week, if you look back over the last 100 years, that relationship doesn’t hold.
And as Mundy points out, US earnings forecasts are still being cut. In fact, he’s so wary on prospects for the US market, that he currently has a short position in US stocks.
In short, the bulls’ strongest argument is that a taper delay means more cheap money sloshing around the system. And much of that cheap money will end up being used to buy shares.
But the taper will have to start eventually. And before we get to that point, the US has to navigate some very choppy waters as the debt deadline gets closer. If, like me, you fear that Obama and Congress are going to make a massive hash of dealing with the debt deadline, buying US shares makes no sense right now.
But even if you think I’m being naïve, and that politicians will always do a deal when their backs are to the wall, the US stock market still doesn’t look cheap enough when you consider the outlook for earnings. I’m steering clear.
There are plenty of more attractive places to invest – in this week’s MoneyWeek magazine Roundtable, our experts give their views on where they think you should be putting your money today. If you’re not already a subscriber, get your first three issues free here.
Our recommended articles for today
Investment trusts are a relatively cheap and simple way of investing in the stock market. In this video tutorial, Ed Bowsher explains why at MoneyWeek, we much prefer them to other funds such as OEICs and unit trusts.
How is the tapering of quantitative easing affecting emerging markets? And where should investors look for profits? John Stepek talks to our Roundtable panel of experts to find out what they’re buying.
New to MoneyWeek?
Welcome, and thank you for visiting us.
Here at MoneyWeek, our aim is simple. To give you intelligent and enjoyable commentary on the most important financial stories of the week, and tell you how to profit from them.
If you've enjoyed what you've read so far, I've got something you'll definitely be interested in.
Every working day the MoneyWeek team sends out a hard-hitting email, 'Money Morning', giving you a rundown of the latest financial events, and revealing what you should do to maximise profits and head off losses…
And with your permission, I'd like to send you Money Morning for FREE.
To sign-up enter your email address below.
We hope you enjoy your stay on the site. Good luck with your investments!
Digital Managing Editor, MoneyWeek