A Tale of Two Markets: Overvalued Stocks and the Declining Dollar

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 |  Includes: BAC, BMT, C, GE, IIM, MUB, PWZ, PZA
by: Marc Courtenay

Fed Chairman Ben S. Bernanke said after a Nov. 16 speech in New York that it’s “not obvious” that asset prices in the U.S. are out of line with underlying values after a 64% jump in the Standard & Poor’s 500 Index from its March low.

My favorite charts to exemplify this are the 1-year charts on GE (NYSE:GE) and Bank of America (NYSE:BAC). Here they are, one on top of the other. Considering their debt issues (and trillions in derivatives), is it not obvious that they are very over-valued? Didn't Bernanke hear Meredith Whitney's interview with Maria B. on CNBC this week? Are these not super-inflated bubbles?
Chart for General Electric Co. (<a href='http://seekingalpha.com/symbol/GE' title='General Electric Company'>GE</a>)
Chart for Bank of America Corporation (<a href='http://seekingalpha.com/symbol/BAC' title='Bank of America Corporation'>BAC</a>)
You would see the same thing if you saw the chart for Citigroup (NYSE:C).

The other "tale" about the stock market is that a declining dollar is actually good for the stock market. That is the perception and it fundamentally makes sense. From my point-of-view, the tale of the stock market is one riddled with a "hidden agenda". Exchange specialists and exchange insiders buy very low in plummeting times like March 2009, and they short stocks and sell their own inventory when the stock market gets way over-valued (which Bernanke, on some level, knows we are at, else why would he say the over-valuation is "not obvious" when it surely is).

Recently, Mr.Bernanke made a passing reference to the dollar. He didn't say much. Here's the whole quote:

The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.

Their "dual objectives" seems to be obvious. In truth, there is absolutely nothing there that suggests the Fed is planning to do anything about the weak dollar. In fact, all he's doing is justifying the recent decline in the dollar. (No wonder gold and silver is rallying...they represent the only strong "currencies").

Their other objective is to virtually force people to invest in the stock market for hope of some dividends and capital gains. The fed has helped make the stock market "the only game in town" (although the commodity market has done well too).

Another "market" that is so out-of-whack it isn't funny is the municipal bond market. My colleague Robert Williams, who happens to be the Executive Editor for Investment U and The Oxford Club pointed out some realities there to ponder:

"Something's amiss in the municipal bond market. Year-to-date, "munies" have behaved more like momentum stocks than their intended purpose of providing a safe yield.

"Consider this: A handful of closed-end muni funds have averaged a 46% return so far this year.

"The rally, of course, was borne out of the financial crisis, when investors and institutions alike went furiously scrambling to safety.

"The novice move was into cash. But the smart money flowed strategically into the bond market. And a lot of the action was in municipal bonds. (The junk bond market is similarly overheated.)

"What's noteworthy, however, is that when the market's sanity returned in March, the muni rally chugged on. Counterintuitive, to say the least.

"So what gives? The stimulus package.

"Specifically, sales of "Build America Bonds," created under President Obama's economic stimulus package, rose 28% in the third quarter, as municipalities chased the bonds' abilities to lower interest costs.

"More than $51 billion of such bonds have been issued since their inception.

"The federal government pays sellers 35% of their interest cost. The subsidy is needed by states coping with an 8.2% annual decline in tax collections in the first half," according to a Bloomberg report.

"Clearly, the bonds are propping up the muni market. (The effect they're having is quite intriguing. But beyond the scope of this article.)

"For now, just take note that the federal Build America subsidy is only available for bonds issued by before midnight on December 31, 2010. Beyond that, all bets are off. (Can you say "thud?")"

Take a look at the 1-year chart on PowerShares Insured National Muni Bond ETF (NYSEARCA:PZA) as an example of the muni-bond bubble off the lows of a year ago:
Chart for PowerShares Insured National Muni Bond (<a href='http://seekingalpha.com/symbol/PZA' title='PowerShares National AMT-Free Municipal Bond Portfolio ETF'>PZA</a>)Similar charts for other muni funds such as IMS, BMT, and MUB. With the state of California in fiscal crisis, it won't surprise you to see the PowerShares Insured Muni California Bond ETF (NYSEARCA:PWZ) also looks quite frothy:
Chart for PowerShares Insured California Muni Bond (<a href='http://seekingalpha.com/symbol/PWZ' title='PowerShares California AMT-Free Municipal Bond Portfolio ETF'>PWZ</a>)

The stock market is seriously overvalued, but the Fed-induced, media-massaged "hope and hype" rally probably has at least another month to go.

The municipal bond market looks like a blimp (think "The Hindenberg") ready to crash and burn. At best, both the stock and municipal bond market are ripe for a big correction, which will actually layout another very good buying opportunity.

One final hint: If the "smart money" is about to short the stock market in a big way, shouldn't we be following their example? Shouldn't the average investor look for ways to "piggy back" on the methods and traditions that have allowed the stock exchange insiders to make tons of money for themselves and their biggest customers... whether the markets go up or whether they go down?

Disclosure: I currently own only C and none of the funds mentioned.