Is A Major Stock Market Sell-Off Coming?

Byron Wien, a well-known market analyst and  vice chairman of Blackstone Advisory Partners. is bearish on the US stock market.

He told CNBC:

I expect the S&P to end the year about where it started. The stock market had a good January, but I think we end where we started. Right now the market keeps going up because liquidity keeps finding its way into equities[...] Nothing bad had happened yet in Q4. No fiscal cliff, no sequester and the payroll tax holiday was still in effect.

[And yet GDP dropped 0.01 percent during the quarter.]

Multiples usually expand when interest rates come down – the next big move in interest rates should be higher – I don't think you can count on expanding multiple.

The way we see things at EPJ, there is no indication that the US stock market will end up where it started. In fact, at least for the first few months of the year, we expect the stock market to continue to climb in spectacular fashion. The Federal Reserve is pushing massive amounts of new money into the economy. If this continues, the stock market, real estate and commodities will continue to climb---and probably accelerate in price advancement.

Wein simply doesn't have an in depth view of what is going on. He mentions the decline in GDP in Q4. However, as EPJ has pointed out before, a large factor in the decline was the drop in military spending, which seemed to be stuffed into Q3.

Thus, the decline in Q4 is not indicative of what is going on throughout the economy. If you look deeper into the numbers, key sectors showed strong advances in Q4. Business investment in equipment and software rose 12.4 percent. Residential investment (housing) climbed 15.3 percent . And consumer spending was up 2.2 percent.

In other words, the Bernanke manipulated boom is on and should be reflected in Q1 2013 data, that will not have the Q3-Q4 defense spending as a distortion factor. If it wasn't for the decline in federal government spending (mostly defense spending related), the Q4 growth number would have come in at a positive 1.32%, not the 0.1% decrease.

As for Wein's concern about climbing interest rates, I also expect that interest rates will climb. However, unlike Wein, I do not believe that a direct correlation between interest rates and capital goods prices, such as stocks and real estate, exists, and that rising interest rates mean falling stock and real estate prices. Indeed, during the recent January climb in stock prices (and real estate), interest rates climbed. The Treasury 10-year note started the new year with a yield of 1.86%. That same security closed yesterday at 2.04%. Empirical data can not be used in the science of economics to develop economic law, but empirical data can be used to prove theory wrong. The theory that stocks and real estate must fall when interest rates climb, was smashed by the activity in the first month of 2013. Despite the climb in interest rates, the Dow Industrials closed on January 31 at 13,860.58, up 5.77% for the month. The Standard & Poor's 500 Index closed at 1,498.11, up 5.04%..

The Fed will allow interest rates to climb some, but not enough to counter the rising prices we will experience. If the Fed allows 10-year Treasury notes to climb from their current level of around 2%, but inflation is pushing prices up by 5%, then it will continue to be profitable for investors to buy stocks and real estate and make the difference in profit. Only if the climb in interest rates is greater than the climb in price inflation will the advance in real estate and the stock market reverse. There is no indication that the Federal Reserve is anywhere near adopting such a policy.

There is no major stock market sell-off in sight.