Why Stocks are Grossly Over-Priced ~ The Risk Averse Alert

Thursday, October 15, 2009

Why Stocks are Grossly Over-Priced

My, my, my... how quickly the illusion of wealth has vanished with the seizure of Wall Street's infinite credit creating machine: three in four companies are reporting contracting revenues, and this in comparison to a not so sparky Q3 '08. (Gulp)

And we have been warned to expect a slow turnaround. Yet there's the stock market behaving as though a return to growth is not only certain, but likely to be robust, too. That silly adage about the stock market looking out 6-9 months in anticipation of coming economic conditions surely is proving useful to those feeding suckers their over-priced shares at a time when revenues still are collapsing.

Now, what exactly do I mean "over-priced?"

Given the broken state of the global credit system, equities offering an historically low dividend yield stand at greater risk of outright being sold because the asset cannot produce the return necessary to help meet debt-related obligations made before (and since) the credit system froze — obligations that no longer can be easily papered over.

No matter that credit spreads are contracting. The simple fact is capacity to create new credit of the sort that largely propels financial asset prices higher has been crippled. Without this there is limited ability to mask the mountain of mis-priced risk built up over the most recent decade in particular.

Big problemo for lowly equity...


At the time of the mid-June '09 peak I went through the exercise of comparing the counter-trend rally up to that point with last year's rally from March - May 2008. RSI provided the foundation for that analysis. Its divergence (at mid-June '09 peak versus early-May '09) was reason to suspect the market's advance off March '09 bottom might be ending, and resumption of the Elliott corrective wave begun October 2007 might then soon commence.

Well, changing the view to one assessing each counter-trend rally in relation to the decline preceding it ... and as well noting the manner in which each rally similarly unfolded ... the "like-from-like" qualities each presents are rather intriguing at this point.

Likewise, the current RSI divergence (top panel) is flashing a warning, as is astonishingly long-deteriorating momentum measured by MACD (bottom panel).

Yet, too, both measures still remain on the "buy side" of their respective ranges. So, all due restraint claiming top is in appears justified.

Nevertheless, this picture still suggests top is nigh. And there's more to this that meets the eye. The picture above begs counter-trend RSI analysis with comment on not only the apparent waning power of the short squeeze, but the fact that, short squeezes apparently have been the principle means by which counter-trend rallies have been mustered at all since October 2007 top.

Speculation on probabilities ahead gain focus given recognition of this dynamic. I should find time this weekend and speak further about this...

Fast Money
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