By Comstock Partners

After an 86 percent gain in 21 months the market looks overbought, overextended and overvalued. Furthermore the economy is unlikely to grow enough to reduce unemployment, lead the Fed to raise the funds rate or cause any significant amount of inflation.

Although the combination of QE2 and the White House/Congressional compromise on the tax extension issue is being touted as the great elixir that will spur economic growth we think that growth will be subdued and temporary. Indeed QE2 is already looking like a failure in its early stages. No matter what the “experts” say now, it was chrystal clear from the get-go that the Fed’s intention was to lower long rates, not raise them. As it stands today the sharp rise in the 10-year Treasury bond is likely to further weaken an already dead housing market by enough to offset any additional growth that QE2 could have provided.

Furthermore, the combination of QE2 and the big projected increase in the budget deficit caused by the compromise tax bill has helped spur another jump in commodity prices that will reduce real consumer income and negate much, if not all of the intended boost to consumer spending.

In addition economic growth will be tempered by the temporary nature of the stimulus, continuing high unemployment, a moribund housing sector, the dire condition of state and local finances, a lack of readily available credit and the ongoing fragility of a banking sector that is still loaded with toxic assets that are significantly overvalued on banks’ balance sheets.

Another major headwind to growth is the ongoing need to reduce household debt to normal levels after the credit binge of recent years. Consumer credit excluding student loans continued its year-long slide in October, falling by $32.5 billion, and the unwinding has barely started. Although consumer spending has perked up recently, we note that a national survey indicated that the percentage of people saying that they used their credit cards over the Thanksgiving day weekend was the lowest (17%) in the 27-year history of the survey. According to major credit card companies, the use of personal credit cards dropped 11% in the 3rd quarter from a year earlier. Does all of this sound like a consumer ready to spend freely? We think not.

As if all of the above weren’t enough, the chances of financial and economic crises overseas, particularly in Europe, China and Japan are exceedingly high. The turmoil in the European Union is not a temporary crisis that will be cured with the wave of a wand.
A number of the weaker EU nations are basically insolvent, and their debts, sooner or later will have to be restructured. The New York Times and Wall Street Journal recently highlighted the exposure of German, French, British and Spanish banks to the debts of Greece, Ireland and Portugal. The IMF has warned that if the EU doesn’t come up with a permanent solution the EU economy could go off a cliff. Meanwhile the austerity measures being imposed on the troubled countries will be a drag on the EU economy for some time to come. As for China and Japan, we’ll leave that for future comment.

In light of these problems we believe that investors are overly optimistic. An 81% market rise in 21 months has already discounted a lot of good news—-some of which will not happen. The market looks overbought and overextended, and is showing signs of an imminent top with lagging breadth, a lower number of new highs, overenthusiastic sentiment, higher-volume down days and a more frequent number of late-day selloffs. At this juncture we think that potential upside progress is limited while downside risk is high.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.


Comstock Partners, Inc. analyzes economic and financial conditions from a long-term macro-economic perspective and makes adjustments based on cyclical and shorter-term considerations. In pursuit of its goals, the firm invests in various asset classes including domestic and foreign stocks, bonds, currencies and derivatives including indices and options

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  • dhdell

    “After an 86 percent gain in 21 months the market looks overbought, overextended and overvalued. ”

    Absolutely incorrect. This logic ignores the possibility that the market, prior to its 86% move, was NOT oversold, underextended, and undervalued.

    Moreover, the uncertainty we see in the U.S., Euro zone, Japan, or Chinese and Australian real estate, is not new to post-2008. Just because we perceived pre-2008 to be more certain and optimistic does NOT mean that post-2008 is less certain and pessimistic. The reality was there then, as is now.

    So, to take market price (or value) pre- or post- 2008 and ascribe it to the fundamentals pre- and post- 2008 is, without a doubt, a stretch.

  • dhdell

    If one did relate price to value, then or now, you undoubtedly must assume that the market is efficient. Which of course it isn’t b/c the world did not change so dramatically in September of 2008.

    A la Joel Greenblatt, take the highs and lowsof any stock in a given year and make a legitimate argument that the business has changed that much. They don’t. And either did the economics of the world, in late 2008, early 2009, or now.

  • BK

    Talk about being stuck in early 2009
    The arguments being presented are very weak to prove the statement in the first line

  • LVG

    tpc, love you man, but it might be time to retire the comstock posts. they’re just permabears on repeat.

  • boatman

    i say stop posting jeff saut.

  • RICH

    From now on we only want to see the posts that point to a higher market and good times ahead? I think TPC has a good balance of both sides of the trade. Which item that Comstock lists is not correct? Perhaps the weakest idea is that consumers will reduce debt to a normal level. Consumers will not reduce debt to normal levels but just enough to start charging again. The top 50% of income produces the majority of consumption. If you change the percentage run up in the market from 86% to 50% most of comstock points were true months ago but are still valid. The market just doesn’t seem to care. I am net long this market with down side insurance purchased yesterday (too cheap not to). Just wondering TPC you talked about being somewhat short a week or so ago. Is that still your trade? Make my own trading decisions but value your opinion– again love this blog– I have learned a great deal from all the posts

  • RICH

    Boatman like your post– you took 6 words to say what I was trying to say in two paragraphs

  • AC

    I find it hard to put trust in someone who can’t spell crystal (“chrystal?”) and has not mastered the use of commas, or lackthereof yet.

  • stpepper

    The frequent use of the term ‘overbought, overvalued and overextended’ seems to me to overused, overexaggerated and overkill

  • EMP


    Yep, feeling pretty good about the economy, market, etc.

    Comfortable in fact.

    Kind of like the body warmth at the center of the herd.

  • Octavio Richetta

    This post is the best contrarian indicator I’ve come up with today. THANKS!!!!!

  • TPC

    The alternative to not having guest authors is having a less diversified perspective and more from yours truly.

  • dhdell

    “The frequent use of the term ‘overbought, overvalued and overextended’ seems to me to overused, overexaggerated and overkill.”

    Too funny.

  • Dan G

    On a more technical note: The vix has reached the lower bollinger band that represents 2 standard devviations lower than the typical Bolinger Band moving averages. It has not failed to predict a decent move down within 3 days for the equity market. Just a short term heads up.

  • dhdell

    Well, I hope so. I have been net short for since 1190 on the S&P. And long Vix.
    Thankfully, I am better at investing than speculating

  • boatman

    actually just kidding about saut TPC…….him n doll….i enjoy a chuckle n don’t mind looking at both sides