Thursday, January 31, 2013

Are U.S. Markets Acting Inefficiently?

By Grant de Graf

CNN Money reports: 
U.S. stocks are flirting with all-time highs, climbing to levels not seen since before the financial crisis. The Dow Jones industrial average is hovering just below 14,000. The S&P 500 recently broke above 1,500 and is inching closer to a new record. Both indexes have risen to their highest levels since October 2007.
Low bond yields and protracted QE by the Fed are some of the reasons why the U.S. market continues to rocket to new highs.

Stocks in the S&P 500 are trading at roughly 14 times expected earnings for this year, which is reasonable.

However, there are significant risks. U.S. growth for 2013 is unlikely to be robust, the challenge of the fiscal cliff has to be resolved and a potential fallout in the European Debt Crisis could significantly dent any progress, which Americans are likely to achieve. Global social political risks remains high, the Iran card has to be played out and North Korea continues to beat the drum.

Historically, the market tends to lag in its response to event risk, hence the difficulty of being able to accurately predict market moves. The gap between market response and actual risk is dynamic and consequently, market inefficiency will always dog traders.

Contributing to the equation of inefficiency, is the fact that investors are being challenged to find a suitable home for their funds. Interest rate yields are at all time lows and real estate fails to impress, especially with the absence of optimism for a strong recovery. This means that investors may be all dressed up, but they have no where to go.

Alternatively, portfolio managers will continue to be content to maintain their percentage allocation to stocks, because on a risk-adjusted basis, stocks will still trump other lower return, lower risk, investment options.


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