[Authors Note–Please Read: This piece is for education and entertainment only. ]

I am not the boy who cried “Wolf!” –Besides, one wolf does not a disaster make.

Actually, I like wolves; they are beautiful, intelligent and have complex social structures. They work together hunting and caring for the pups. Many of the First Peoples’ cosmologies depict the wolf as an important fellow traveler  who has suffered a fate not unlike their own: misunderstood, removed, contained, and demonized (as exhibited by the folktale in the case of the wolf).

[By the way, I am reviewing a series about the Navajo  called “Dark Winds” in the Movies section of this blog.]

In this early phase of AI, this age of robo-advisors, and investment professionals who only ever experienced low interest rates and an “omniscient and omnipotent” Fed, you are not likely to get enough stock-market guidance surrounding the potential dangers  ahead. We are in the critical phase of an 80-year cycle of recurring turmoil (See The 80-Year Cycle), the last marking of which was during World War II.

This time around, we have far more powerful weapons, and are so specialized and centralized that we are much more vulnerable to the loss of critical resources and infrastructure

–And in case you just came out of a  Rumpelstiltskin-like sleep, interest rates are the highest in decades, weather patterns are changing rapidly, and  two of the world’s nuclear powers are currently fighting separate wars with both leaders of  the “hardline” variety.

The market acts as if the only risk is that the Fed does not lower interest rates sooner.

So let’s de-escalate for now and imagine that WWIII is not in the picture. The fundamentals analysis suggests that the market is overpriced with current interest rates.  The Capital Asset Pricing Model suggests that the market, or it’s proxy–the S&P500, should have an expected return of about 10% (Expected Return = Risk-free rate + Beta(Market Risk Premium) or:  5% + 1( 10% – 5%) = 10%–which corresponds to a P/E (Price/Earnings Ratio) of 10. The idea is that you would pay 10 times the annual earnings for a share of stock. I will even use the forward P/E ratio which is more realistic. I will not include any consideration of the 1.5% dividend because that is paid out after earnings per share are calculated.

Earnings for the S&P500 are estimated to be $222/ per share for the next 12 months. Based upon the above-calculated multiple of 10, the implied price of the index would be 10 x 222 or about 2220.  The S&P500 index is currently at 4335, a multiple of closer to 20 times earnings.  This implies one of two things: The market must be anticipating a swift return to much lower interest rates, or it expects earnings to surge higher in the coming quarters. Either way, the market is pricing-in a very rosy 2024!

The technical picture (charts only) is not rosy either. Below is the BigCharts.com three-year and the five-year charts respectively for the S&P500. The three-year chart shows a trendline (red) that, if broken down through, implies a next-stop (black line) of 3800. The five-year chart shows a longer-term trendline (black) that if broken implies a much lower potential target price (black line) of about 2500.

[Note: chart trendlines are a matter of interpretation and no two people will draw them in exactly the same place or way. Their predictive power is not absolute by any means.]

One conclusion that could be drawn from all is that in the face of economic and geopolitical risks, the market is stubbornly predicting the US economy and the world order will stay intact and continue to deliver jobs, stability, and good returns from stocks. Another, less comforting interpretation, is that stocks are not far from levels the breakdown through which implies perhaps a 10% fall, which in itself potentially triggers a greater drop.

It might be worth noting in this context that investors can accept a nearly risk-free 5% return on short-term treasury notes and bills. Some CDs and other income-based investments have slightly higher returns. Of course, if the Fed lowers rates early next year and geopolitical tensions lessen in the interim, returns on stocks would likely surpass that of the 5% safe havens.

WRH