The Bubble That Bernanke Is Creating

I often debate with a couple of my smart buddies what we think of this market.  Lately, anyway, the conclusion seems to be that there is very little to like about it.  It's not cheap for one.  Two, the worst and riskiest stocks are the ones rallying the most.  And in some sectors its absolute mania.  Look at many tech names.  Anything with a "cloud" moniker now is ascribed a near triple digit P/E multiples.  CRM trades at 250x trailing earnings, and 96x forward earnings!  And if its a Chinese Internet company, then forget it.  Is it possible that an online company called Dangdang (Ticker DANG) in China is really worth $2BB, when its forecasting net income of 8mm in 2011?  The market thinks so.  (It listed in December on the Nasdaq).

Like most bubbles in the US, it's significantly Fed driven.  Consider that QE1 (quantitative easing) began back in March 2009.  That was the lows of the stock market.  The S&P ran almost straight up until April 2010, coincidentally a month after Quantitative Easing ended.  Not surprisingly summer 2010 was brutal, and by July and August last year, there was much talk of a fallback into another recession.

I myself was giving 50%+ odds of a recession last July.  Then, in late August, Bernanke announced round 2 of quantitative easing, QE2.  Hooray!  The market has shot up 22% since then, helped along by a healthy dose of fiscal stimulus too.  Yes, our taxes will be going DOWN in 2011, our deficits up.  We are fiscally and monetarily full on the gas so to speak.

So, QE2 ends this June 2011.  If we have a repeat of the last mini-Fed-induced cycle, then I suspect that the rally will last until that time.  We could hit full bubble valuations too by then.  While today we are at historical average valuations of 15x, this could certainly go higher.  Don't get me wrong, I am not advocating getting super long the market now.  I personally think fair value is lower.  (Jeremy Grantham suggests fair value is in the mid 900s on the S&P).  But I find that such momentum rallies tend to leave value investors in the dust.  Yes, I completely missed the tech bubble of the late 1990s.  It makes for frustrating investing sometimes, but my contrarian ways have helped me as well.  I will likely end up mostly in cash by the time June rolls around.

So, the question is, will we get QE3 to keep the market going after June?  I mean, if the Fed just prints a million dollars for everyone in this country, won't we all be rich?  Clearly, the answer is no.  The same reason we won't be all rich is the same reason that inflation is going to happen.  Sure, we could all have a million dollars in the bank, but I am pretty sure that gasoline would cost $50,000 a gallon.  (or something crazy, you get my drift).  We have printed $2 Trillion dollars in a year and a half, and the payback is inflation worldwide.

So, inflation worldwide is starting to really cause problems.  When you have a country like Egypt, where food represents 40% of your expenditures, and food prices rise by 24% in ONE YEAR, then you can get riots.  And toppled regimes.  Certainly a lot of unrest is going on.  Kudos to QE2.  India, Thailand, even Great Britain is at 3.7% inflation.  [Sorry about the last blog, typo'd it at 5.7%].

Either way, inflation is happening here already I am convinced.  The best question I have heard in ages was one asked by David Einhorn to former Fed member Larry Meyer last December.  He asked on CNBC:  "Part of the issue with deflation is:  companies improve the quality of their products.  So, Last month the PPI went down because we had a new car year, and we have a better car for the same price.  So they say prices fall [ie CPI falls].  Now why is it that the Federal Government feels we need a policy response to auto company's making better cars and selling them at the same price.  Why do we need to drive up the cost of energy, food and cotton to offset that?" 

I would always recommend listening to billionaire money managers (David Einhorn) as opposed to journalists (or market pundits) making $50k a year when looking for stock or market advice.  His point is that the Fed is creating a bubble in commodities.  Larry's response was so weak, it illustrated that he didn't even understand the issue.  "You are worried about another bubble in housing?"  Einhorn interjected that he is worried about a bubble in oil and corn.  Even worse, CPI is reported excluding "volatile" food and energy prices.  Amazing.  Someday I'll tackle that one.

So, in addition to this, Fred Hickey puts out a great newsletter every month.  And this month he convinced me to buy more GLD.  I paid around 132.40 today.  He points out that gold has fallen 7% from its peak last fall, and as Fred says, "Gold is up simply because the imbeciles at the Fed are dramatically debasing the US dollar through their negative real interest rates and their monstrous money-printing campaign (quantitative easing).  If money was stable, gold would be too."   It seems that the corollary to this would be:  as soon as the Fed stops easing, then I should sell gold.  However, the Fed simply can never stop printing money.  It's the only thing financing our federal deficits.  I have spoken at length on this issue in prior blogs I believe.

The Chinese have stopped altogether buying Treasuries (going on 2 years now).  They and India are importing tremendous volumes of gold with their currency reserves.  And, the contrarion factor in gold is, futures traders built up their largest SHORT position in gold just this January.  The largest in fact since January 2005.  And as noted in his newsletter, gold shot up 75% in 2005.

I also bought some puts on Micron Technology.  $9 strike, July-dated put options @ $0.40.  The stock is trading at $11.40 today.  The reason is simple.  This company is the airline of the tech industry.  It's lost money the past 3 years, that is until they turned the corner in 2010.  The stock has spiked recently, and for $0.40 an option, I can cheaply buy insurance on a historically volatile stock.  DRAM prices will fall 50% this year, and EPS looks like this the past 4 quarters:  $0.39, $0.92, 0.32, then they only did $0.15 in the November 2010 quarter.   Overcapacity, huge fixed costs, pure commodity play.  Never ever own this stock unless its like 3-4 a share, and a very cheap option worth going long.  And, finally its up 40% in 5 weeks.  Sell.